In a historic move late Friday night (8/5/11), Standard & Poor’s sovereign debt rating committee downgraded the United States’ credit rating one notch from AAA to AA+. While bold, this move was certainly not unexpected. Months ago, S&P fired a shot across the bow, announcing that the government’s AAA credit rating was in peril. They later stated that Congress and the Administration needed to address the growing deficit and pass a debt ceiling law that reduced the deficit by $4 trillion. Congress failed to get that done. S&P responded as they said they would and downgraded the US credit rating.
So what happens now? In reality, not much. US Treasuries are still the global safe haven when uncertainty exists in the financial markets. Both Moody’s and Fitch, the two other major credit rating services in the US, continue to rate US debt as AAA. Unfortunately, Congress still needs to address the deficit issue, most likely with a balanced approach that considers both entitlement spending cuts and revenue increases. That won’t be easy. This Congress has become the poster child for political gridlock. Fiscal policy, like any other government policy, is the result of the political process. In a divided two-party government, that typically requires compromise. But compromise does not mean “give me what I want, how I want it.” Compromise means taking the best ideas from both sides and formulating a policy to move the country forward. Let’s hope they can do that.
It’s important to keep this all in perspective. Don’t panic. We do have budget deficit and long-term debt issues that needs to be addressed. That is for sure. But we also have an economy that is sputtering along, trying to recover from a very long and deep recession. Typically, economic growth could help us address the problem. Today, it is another issue that needs help. It appears that the major factor lacking in this economic recovery is demand. The major reason there is little demand is a lack of confidence. With 2/3 of the nation’s economic growth coming from consumers, consumer confidence is very important. A well thought out and well crafted bipartisan fiscal policy could go a long way to improving that confidence.
In the meantime, let’s keep a few issues in mind:
• The S&P rating downgrade of the US credit in no way affects the country’s ability to pay its bills. Typically, a rating downgrade would increase cost of borrowing for a debtor, but initial market response actually lowered treasury interest rates.
• Moody’s and Fitch both continue to give US debt their highest AAA rating.
• Initial market response supports the US Treasury’s role as a safe haven investment.
• Warren Buffett, the world’s most successful investor, said S&P erred and the US should be rated “quadruple-A.”
• AA+ rating is still very high quality, the only higher rating is AAA.
• This could act as a wake-up call for Congress and the Obama Administration to get a comprehensive debt reduction package passed.
While the chances of another recession have increased slightly, we think that is still unlikely. US economic growth should continue in the 1 – 2% range for the next few quarters. This will be slow, uncomfortable growth, but it will be growth. And although the stock market values plummeted the first few days of August, underlying market fundamentals remain okay. Corporate profits are solid, with almost 75% of companies meeting or beating 2nd quarter estimates, and many companies are awash in cash. Valuations are below their long-term averages and interest rates should remain low for some time. That means the market should have upside potential if corporate profits continue to grow.
We will continue to monitor this dynamic situation and its affects on our investment strategy and our clients’ portfolios.
