S&P Fires Warning Shot at Congress

Late Friday evening, well after the market close, Standard & Poor’s announced that it was lowering its credit rating on U.S. Government debt obligations to AA+ from AAA. This, not totally unexpected, move is the first such downgrade in the history of The U.S. It occurred after the other two leading credit rating agencies, Moody’s and Fitch reaffirmed their AAA rating but with a negative future outlook. S&P made it clear in their statement that the downgrade was based, not on a question of the ability of the U.S. to pay, but rather the amount of fiscal brinksmanship displayed during the disgraceful performance of our Congress. For an excellent commentary on this I urge you to read a timely post in The Economist http://econ.st/rr2d5X. I agree that this downgrade appears to be aimed squarely at the U.S. Congress and hence indirectly at ourselves. We must limit our long term obligations via entitlement programs (Medicare, Medicaid and Social Security) and we must address these issues now.

The downgrade tells us very little that we didn’t already know. S&P held true to its reputation for gleefully bayoneting the wounded after the battle. The downgrade may have negative credit implications for any entity public or private that depends heavily on U.S. Government spending. I will be writing more about this later as this works itself out. In the regular course of life this downgrade means very little as all credit ratings are relative. If you downgrade the cream of the crop, then everything below moves down a notch also. In fact, more than few respected analysts have noted that AA+ is becoming the new default rating for risk free. Despite S&P’s ongoing hissy -fit with Congress, the United States still enjoys a high credit rating (still AAA from two of the three agencies) and is not expected to have any trouble meeting its obligations in the short run and unlike the PIG countries in Europe controls its own currency.

The S&P downgrade of U.S. debt doesn’t change our investment thinking, mainly because our analysis and portfolio positioning already takes into account the serious domestic and global debt problems that influenced the downgrade. The significance of the global debt problem is that it will likely take many years to reduce this debt, and as it is being worked down it will hamper economic growth. The markets appear to be resetting to lower levels in broader reflection of this view that growth is likely to be slower than some were expecting.

Which brings us to the ultimate question, why, after the down grade did the prices for U.S. Treasury bonds actually go up? And why are foreign investors fleeing to the dollar and U.S Treasures as a safe haven? When you think about it, selling stock and buying Treasuries is very un-rational, not that markets are renowned for rationality. A more compelling consequence is that the downgrade scares U.S. consumers back into the recession hiding place from which they only recently exited. This has indeed stepped up my consideration of such a possibility which as late as early last Friday I considered as not very likely http://bit.ly/qjrJ99.

In the meantime, we expect a lot of turmoil in the markets and would be inclined to sit tight and watch for opportunities if stocks cheapen even more from where we are currently. I would reiterate that this is not 2008. The difficulties we face here in the U.S. are nowhere close to those we met at that awful time. I cannot say the same for our friends in Europe however, where it does look a lot like 2008. There are some very good U.S. companies that are not in any financial difficulty with generous yields that are looking very buyable. Morningstar published an excellent piece on what to do in a turbulent market. In Brief:

Step 1: Check adequacy of cash reserves.
Step 2: Check your long-term positioning.
Step 3: Initiate defensive hedges with care.
Step 4: Make sure you're taking advantage of "gimmes."
Step 5: Develop a strategy for deploying cash.

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The above commentary is the opinion of the author and should not be construed as investment or tax advice. Always consult a qualified investment and/or tax advisor before investing or changing investments.