The widely reported Dow Jones Industrial Average lost over 600 points yesterday, mostly in response to speculation over what is to come as a result of the S&P downgrade of US Government Debt.
Interestingly, the same agency that was scrutinized for not calling attention to possible problems leading into the 2008 financial crisis is now being questioned for suggesting that the US may no longer be a “risk-free” investment. On Monday, President Obama stated in a prepared speech that the US will always be rated AAA. I suggest both S&P and the President are simply doing their jobs.
It is hard to imagine that it is possible for the US to keep a AAA rating for our debt, when our politicians are locked in disagreement over how much to spend and how much to tax. Personally, I believe that the downgrade was not only appropriate, but completely necessary. I also believe the President’s comments regarding the downgrade were necessary as well, as anything less could have led to a much worse result.
We should expect a lot of volatility in the coming months as we begin to figure out what it means that as a country, we are no longer a AAA rated issuer of debt. As of this morning the market is already up 200 points, illustrating its capriciousness as future economic growth is being called into question. That is why it is imperative to have a long term perspective and a deeper understanding that reacting at a time like this creates more harm than good. Fortunately (kind of) we have a recent memory of what benefit comes from perseverance. Here are some thoughts I have come across or formulated as Avalan has looked at the situation:
- One could argue that with the downgrade of US debt instruments, the Eurozone will have a much harder time fixing the already difficult crisis they are facing, with several member countries on the brink of insolvency. We are keeping a very watchful eye on this part of the world, however EU political and monetary policymakers are responding aggressively and they should be able to manage what are eminently tractable issues
- Consumer confidence remains very low and the markets of the last week have shown what that means. Confidence is closely correlated to growth, and depending on how markets unfold in the coming weeks, that will determine how things progress. While the odds of another recession have greatly increased, we at Avalan believe that growth will continue (albeit slowly) for the foreseeable future.
The Housing Market
- One statement that was clear in the downgrade of not only the US debt, but the subsequent downgrade of Freddy Mac and Fannie Mae, is that S&P does not see an end to the housing crisis or any indication of a rally in prices or new starts. While this could be devastating for continued economic recovery and job growth, early indicators tell us that we should not see immediate increases in interest rates and for a while things will look a lot like more of the same.
Already priced in
- A slow-down in growth had already been priced into the market last week and much of what we saw on Monday is tied to overall investor sentiment. Coming to the Monday open, we felt that if the debt markets behaved in an orderly fashion, further sell-offs would look much like the market trying to find a bottom, and a new rally point to close the year on a stronger note. Due to the fact that markets do not always react rationally, it is important for us to keep our eye on the ball and realize that there is nothing we can do to control them.
The reality of the “downgrade”
- Going from a AAA to AA+ rating only increases the risk of potential default by 0.01%. S&P was not saying that is a risk at this point, but instead was sending a notice that we cannot continue to live beyond our means. The time of kicking the can down the road needs to end. We need to hope our elected officials hear this message.
We are now in a situation where there are several states that have a better credit rating than the US Government. Strange, as so much of their budgets rely on that same entity to function. Regardless of these developments, the S&P 500 has eroded all of the gains it has made for the last year, and is now in the red just over 1% YTD. Foreign markets have not faired quite as well, but bond markets have remained in the black even through this recent sell-off. In fact, it was 10 year Treasury that rallied Monday to an all-time low yield due to money flocking to the “safe” asset that was just downgraded! Most of our investors year to date are flat after Monday and in the black for the 12 month period ending Monday. We encourage you to reach out to us to discuss the details of your portfolio should you wish, or look forward to discussing these topics at our upcoming quarterly meetings.
We at Avalan continue to monitor the situation and look for opportunities where presented. We understand that the single most important thing to our clients and potential clients is keeping the wealth they have created; and our focus remains on fulfilling that mission. In the coming weeks, we are planning on launching a series of events focused on sharing new ideas and concepts that are continually evolving in the volatile world we are living in. Stay tuned for details and further commentary to stay informed as we continue to assist you to Take Hold of Your Wealth ™.