On Aug. 5, the ratings agency Standard & Poor downgraded the rating of the United States’ debt from AAA to AA+. While S&P had previously warned that a drop in the rating was possible, this action is still a surprise to many. The other two ratings agencies, Moodys and Fitch, have maintained their AAA ratings. This move by S&P clearly hurts the prestige of our country but likely will not cause any major long-term financial repercussions, though it will have some short-term impact.
Clearly, the recent debt ceiling compromise precipitated the move by S&P. The amount of the budget cuts was relatively minor and nothing was done to address entitlements or the tax system. In addition, future budget cuts will need to be worked out by a new debt-reduction commission. In essence, making the difficult decision was postponed. It must also be remembered that the rating agencies gave AAA ratings to sub-prime mortgage debt prior to the financial crisis, which was a colossal mistake, so S&P is being more cautious now.
Looking at the market action Monday morning, Treasury yields were down, which means the price of Treasuries are higher. This move by S&P is not hurting the safe haven status of U.S. Treasuries. However, stock markets throughout the world were down, as this move interjects more uncertainty into the financial system.
Recently, talk has again surfaced regarding fears of a “double-dip” recession. If one looks at recent data, such as the July employment report, unemployment claims and auto sales, the economy actually improved in July versus June. Evidently, consumer confidence has weakened recently given all the uncertainty created by the debt ceiling impasse, the stock market correction and now the U.S. debt downgrade. Given all these negatives, the economy will probably soften somewhat in August, but that does not necessarily imply that we’re going into a recession.
This recent flight to safety will offer some benefits to consumers, as commodity markets are dropping, which means lower gasoline prices. Also, 15-year fixed rate mortgages are down to 3.5% for conventional loans, which might entice some people to purchase a home or refinance a mortgage.
In the short run, expect higher than average volatility, meaning plenty of days with significant moves, both up and down. The stock market is currently undervalued given current earnings, so in essence, equities are already predicting a recession, which may not occur. Trying to time the market in the short run is very difficult, so for the longer-term investor, I recommend maintaining normal positions in stocks, despite the current unpredictability.
