In this week’s bulletin:
- For the first time in its history the US lost its AAA credit rating although this was much about political considerations rather than financial stability
- Spanish and Italian debt worries and the subsequent ECB actions confused investors
- Trading volumes spiked dramatically towards the end of the week driving substantial market movements in a typically quiet period
- Corporate reporting was strong with many companies exceeding profit expectations
- Clients should not panic and sell assets at reduced prices
- Diversification remains critical for all investors
- Volatility creates investment opportunities for astute investors
In 2008 investors experienced stock market volatility caused by:
– the well-publicised credit crisis, initiated by the sub-prime mortgage problem in the US, and
– worries that the US would go into recession.
Writing today, with more than a hint of déjà-vu, world markets have again fallen sharply, with this time, the reasons for the fall being:
– the well-publicised Sovereign credit crisis affecting the Eurozone and
– worries that, despite resolving its immediate borrowing problems, the US may yet fall back into recession.
In many ways then, the issues that the markets are worried about today are not entirely new and have been known about for some time. However, on Friday evening, after the markets had closed for the weekend, something new did happen. For the first time in its history, the US lost its AAA credit rating as Standard & Poor’s downgraded it one notch to AA+.
This note explains what has happened in both the US and in the Eurozone and what we believe this is likely to mean for investors, both in the short term and after the dust has settled.
In its leader column at the weekend, the Financial Times stated that “If one good thing comes out of this week’s market panic, it would be to shock politicians out of the complacent parochialism in which they sought refuge before the danger was over. Things are still not as bad as 2008.”
We agree. We also believe that now is not the time for investors to panic and we explain how markets behave in times of crisis and having analysed the performance of the FTSE 100 index, why this is not the time for investors to sell equities.
The decision to downgrade the US taken by Standard & Poor’s on Friday was, in their words, as much a judgement about the political leadership in the US, and in particular their willingness to put political differences above seeking a solution to their self-imposed debt ceiling, as it was about the fact that they regard the proposed solution as no more than a temporary fix to America’s debt dependence.
However, their decision was not followed by the other two major debt rating agencies, Moodys and Fitch, both of whom confirmed they will maintain their AAA ratings for the US. To this extent, whilst the short term result is likely to see markets unsettled, indeed they have fallen by between 2% and 4% in the Far East this morning, and the UK is down c1.5% in early trading, it may not actually be a significant move. Asked about whether the US deserved to be downgraded, Warren Buffet speaking over the weekend gave an unequivocal answer. “No”. Indeed, one of the consequences of the continued volatility has been a further reduction in US bond yields as investors seek the safety of US Treasuries!
He pointed out that there is no question of the US defaulting on its debt, nor is there any question of its ability to repay it. In fact, he went on to say, “if there was a quadruple A rating, we would give it to theUS”
Following the downgrade though, there are now just five countries in the G20 which have a AAA rating: France, the UK, Germany, Australia and Canada. Even after its downgrade, the US remains the next most highly rated of the G20 countries.
The other point investors should take note of is that, despite the protests from countries like China and Russia, who understandably are concerned that their holdings of US Treasury Bonds should not fall in value, they are unlikely to abandon the US as it remains one of their largest export markets and their purchases of US dollars helps to prevent their own currencies from appreciating too much against the dollar and thereby making their exports more expensive.
US debt ceiling
The uncertainty regarding the US debt ceiling that we saw last week has moved from the economic stage to the political.
The legislation will cut spending by up to $2.4 trillion over 10 years and raise the debt ceiling by $2.1 trillion until 2013.
As The Financial Times noted last week, even full implementation of the savings will only account for just over 1% of projected gross domestic product over the decade, and falls short of the minimum $4 trillion in deficit reduction that most budget analysts say will be necessary to stabilise long term debt levels.
However, since signing the deal to allow the new debt ceiling to come into effect, US economic data continues to be weak, so much so that doubts remain about the strength and sustainability of any economic recovery, despite better than expected US payroll data on Friday.
Given the action taken by Standard & Poor’s, a more robust solution to the US debt problem is now more likely to be found and further measures to support economic growth – which, when they come will provide support to US companies and hence the US stock market – are likely to be needed.
As well as the US, last week also saw politicians in Europe trying to formulate fresh responses to their own debt crisis, as investor support for Spanish and Italian bonds fell away sharply. The lack of support saw yields rise to 6.45% and 6.25% respectively, close to the levels that pushed Greece, Ireland and Portugal into EU-funded bail-outs.
Initially, markets believed that the European Central Bank (ECB) would step in to support European bond markets. What transpired though was limited support for Ireland and Greece but no support for Italian and Spanish bonds, a move which shocked and surprised investors. This triggered a fall in investor confidence and the re-emergence of concerns about the political will to find a permanent solution to the Eurozone’s problems.