One year after AAA credit downgrade…
It is exactly one year since the U.S. credit downgrade from AAA to AA by Standard & Poors, a move primarily motivated by the inaction in Congress to raise the debt ceiling. At the time, the event threatened to throw financial markets into chaos – the Dow Jones average crashed over 600 points that day. Fears of rising interest rates and a falling dollar were stoked. And Gold was expected to go to the moon. Much of these expectations were rational. If anyone borrows beyond their means, their credit suffers; your credit card company may raise your interest rates; you may not be allowed to borrow any more and so on and so forth. The ultimate objective of the S&P downgrade, in fact of any sovereign nation downgrade, is that the nation will get its act together, reduce its debt (as measured by its debt-to-GDP ratio), polish up its policy-making apparatus and move into a more fiscally more responsible position. That’s what is expected in a normal world. Aha.. but are we living in a normal world anymore ?
Let’s take a look at where we were in August 2011 and today.
- The interest rates on 10-year Treasuries was about 2.4% then. Today, it is a little over 1.5%, a drop of over 33%. These were supposed to go up.
- The 30-year Bond was trading 131, today they are at 151. If interest rates rise, then the value of Bonds are supposed to go down. Well, we know this did not happen, so this is not a big shock.
- Stock markets would not perform well either. But the S&P 500 has risen from 1200 to 1390 today, a rise of 15%
- Gold was supposed to go up, but has fallen about 5% since then. And of course, the US dollar has seen a dramatic rise in value this year.
- The U.S. government was expected to cut its debt, but admittedly, we have grown debt by at least the deficit amount for the last one year – that’s about $1.2 trillion (gulp) at least.
- And what about a well-oiled policy machine in Washington – well, let’s not even go there. America’s political landscape is degenerating by the day, things are only more deadlocked than ever, and we face the “fiscal cliff” in January 2013 – a $600 billion worth of spending cuts and tax hikes.
S&P 500 – One Year Chart (Click to enlarge)
There are several smaller metrics that have behaved exactly opposite of what was supposed to happen. Every economic and finance principle the world has learnt is absolutely being turned on its head in one year. Now, you could justify all of this with several arguments – S&P just made a bonehead move, US Treasuries are higher only because Europe is a mess, the US Dollar is the global reserve currency and so on. All of this may be true, but undoubtedly, we’re still kicking the can down the road. And with every kick, our ability to kick it harder is diminishing and the can doesn’t travel that much anymore. This is definitely not a normal world we’re living in. It’s time to be vigilant and nimble with your investments, but the S&P in the short term has entered a bullish phase. More on that in the next post.