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Nowhere to Run, Nowhere to Hide

Inflation sparked a massive selloff in the major stock indices.

Updated from 4:20 p.m. EDT

Hundreds of billions of dollars fled the stock market Friday, as bearish investors sought whatever bit of safety they could find in the face of collapsing stock prices.

Inflation, the mortal enemy of all investors, catalyzed the carnage Friday. A government report showed that consumer prices rose 0.7% in March.

The inflation news put nearly everyone on the defensive because it comes at a time when

Federal Reserve policymakers are in the midst of a string of interest-rate increases, which could begin to threaten the very foundations of the record 109-month U.S. economic expansion.

The U.S. government bond market was the biggest beneficiary of the stock-market rout, even though bond prices only rose modestly. That's because the flow out of stocks and into bonds only really served to anesthetize the bond market against its own inflation-related anguish.

In late Friday trading, the 10-year Treasury note was up 10/32 to 104 22/32, yielding 5.86%.

Meanwhile, the

Nasdaq

plunged 356.74, or 10%, to close at 3320.04, while the

Dow Jones Industrial Average

plummeted 616.23, or 6%, to 10,307.32, its biggest point loss ever.

Normally, bond markets sell off in the face of inflationary signs because of investor fears that the Fed will raise interest rates. But Friday's stability was seen by many as a sign that real money was moving into bonds, as investors flocked to the relative safety and liquidity of Treasury securities.

"The ability for Treasuries to hold their ground in the face of such bad inflation news is clearly a sign that the bond market was supported today," says Rudolph Thunberg, president of market analysis firm

Ried Thunberg & Co.

But bonds were only part of the story. The reality is that as stocks sell off, wealth is being destroyed.

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"In days like this, there is money is going into thin air," says Alfred E. Goldman, chief stock market strategist at

A.G. Edwards & Sons

. Goldman says that for every seller of a security, there is a buyer on the other end of the deal. In the case of a plunging market, that means that virtual money is shrinking at a rate faster than actual money.

Goldman also says that stock-market money is likely being converted to cash as investors ride out the volatility. "This is a very normal correction, and we see no evidence that the long-term bull-market trend has reversed," he says. "A lot of smart investors are keeping their money available because there will be a tremendous amount of buying opportunities when the correction is over."

While it remains to be seen whether people actually will step back in, it's clear that some individual investors are moving into cash positions.

One online trader, Gary Sewell of Apple Valley, Minn., says he's getting out. He's funneling some money into puts, or bets that stocks will fall, on his remaining equity positions. The rest is going into his money market account. "It earns better interest than putting it elsewhere, and I'm not worried about them going bust," he writes in an email.

He adds, "I'm definitely down for the year in unrealized amounts (on paper), but have only given back part of realized gains that I had taken during the first quarter."

Another investor, Al Frowiss of Rancho Santa Fe, Calif., says he parked his money in a cash money market account at his brokerage. "Following a devastating last 2 weeks or so, I capitulated earlier this week, thus, mercifully, I missed the last 2-3 trading days," he writes in an email.

Anthony Crescenzi, market strategist at

Miller Tabak & Co.

, agrees that a lot of stock-market money is being converted to cash and money-market investments while investors take a breather from the turmoil. That is also the case with many mutual fund managers, who are likely selling stocks to increase their cash holdings to handle a possible rash of redemptions.

"Even though data still show that funds are still seeing some inflows, fund managers are probably not putting all of the money to work," Crescenzi says. "They're waiting for a better level to get back into the market, and they could be getting ready for redemptions."

To a lesser extent, he added, a significant trickle of money might be flowing into overseas markets, many of which are starting to look more attractive after investors have chopped away large chunks of the Dow and the Nasdaq in recent weeks.

Crescenzi noted that Japanese and broad European stock indices have outperformed U.S. indices so far this year, and softness in the dollar vs. the yen is at least one piece of smoking-gun evidence that money has been flowing out of the U.S.

"Given the situation with the Fed and interest rates and the economy and the turn in the stock market, it seems likely that money has flowed offshore," Crescenzi says.

Senior writer Caroline Humer contributed to this story.