Market’s Reaction to S&P Rating is probably Melodramatic

Three days ago I wrote: “Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue?” 

Today, changing the outlook for US debt from stable to negative, Standard and Poors (S&P) said "We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns”

Excerpt  from Bloomberg, August 31, 2007 :

“S&P and Moody's Investors Service failed to downgrade bonds backed by loans to borrowers with poor credit until July, when some had already lost more than 50 cents on the dollar. …U.S. Senate Banking Committee Chairman Christopher Dodd said yesterday credit rating companies must explain why they assigned ``AAA ratings to securities that never deserved them.''

The irony of S&P’s ratings today, warning about AAA rated US Treasuries, given Senator Dodd’s comment  3 ½ years ago,  is notable. Sort of in line with "be careful what you wish for".  

Given the track record of rating agencies and their own limitations/warnings regarding their comments, one must wonder why markets would react in any major way to anything they say.  Click on the below for warnings from S&P itself regarding what ratings are and are not.
           http://www2.standardandpoors.com/aboutcreditratings/

What we know after the S&P outlook change is the same as what we knew before.  We knew we had a deficit problem. We are expecting higher interest rates.  So why have world markets lost almost $600 billion in value, in one day, in reaction?

People act irrationally when they become fearful.  Sometimes being reminded about risks that they know already exist just makes people panic from fear.  

The value of the US $ in currency trading generally  rose after the S&P report today—exactly opposite the direction it should have gone if the US is less credit worthy—it went the direction you would expect during a general rise in the level of fear and uncertainty  in markets.

As I said on Friday, the Wall of Worry Gets Taller as potential risk and opportunity both grow.  

The important news will be what we don’t already know.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.