As I expected, the U.S. downgrade by S&P was going to be a lot worse for the stock market than for treasuries. This came as a major surprise for most people as it is counter intuitive. The reason being is that it was not so much a loss in confidence in the ability of the U.S. Government to pay its debts as it was a signal that the free spending ways of the last 50 years is ending. History shows that sovereign downgrades spark action in governments to tighten their belts and cut budgets. Less spending, whether it be in employment, infrastructure or social services including Social Security and Medicare means less aggregate demand in an economy and thus less revenue and profit.
In simple terms, the downgrade applies very little to the creditworthiness of U.S. Treasuries, even though we are now rated below Finland, Luxemburg and the Isle of Man. It was only S&P that downgraded us, while both Fitch and Moody’s left the AAA rating. The real effect, and what it really means to you and me, is that it is going to light a fire under our politicians ass to cut spending at a time when our economy is already incredibly fragile from not enough spending and consumer demand (70% of our economy is consumer spending) from our aging population which naturally spends less as it gets older and an already massively indebted population who has no more spending power.
With the recent drop, there is a lot of talk about this being similar to last year’s correction. This is not Déjà vu all over again. The global economy is slowing and the global debt crisis is getting more intense, and it’s not just a U.S. problem either. It is a global problem, particularly amongst the developed world. So, it’s not just us that is bankrupt, but Europe as well. It started with Greece, recently spreading through Italy and Spain and just this morning reaching France. Our banking crises of a couple of years ago, is rocking through Europe which will eventually reverberate back here.
These issues and more are exactly what I write about in Facing Goliath: How to Triumph in the Dangerous Market Ahead. My son, Josh recently asked me how it felt to be right in predicting what is going on in the economy and the markets. What a question. How do you explain the bittersweet joy and pain to a kid?
Yesterdays Federal Reserve statement was remarkably blunt, admitting that our economy was slowing more than previously expected and that monetary easing would continue until the cows come home. I discussed this in-depth live on Fox yesterday as I appeared as the primary market analyst to decipher the Fed statement as it came out, so be sure to view the video clip. I was pleased that they will continue with QE Mini-Me and leave rates at zero through 2013. I was disappointed however that they didn’t come through with a new asset purchase program or a full blown QE3.
The current uncertainty is creating tremendous opportunities in income producing investments and especially short term corporate bonds (not bond funds), with yields now exceeding 10-12%. Even with the market down 500+ points as I write this, many of our dividend stocks and Preferreds are up. Corporate bonds got hit as hedge funds were forced to liquidate bonds to meet margin calls to cover the money they lost on stocks. (Paulson’s hedge fund announced a half hour ago that they are down 31% this month alone!) These depressed prices are most likely very temporary and a boon to the “reasonable” investor who simply needs decent returns without all the headaches and heart attacks. After all, if you can get a 10-12% yield per year and get your principal back in just a just a year or two, why take all the risk of the stock market? Invest for need, not for greed!
The lack of a QE3 is not good news for the stock market, and we have implemented selective portfolio hedges through inverse funds which go up when the market goes down. The next few days are critical. If we do not see a true bottom formed with a strong rally, not just a “relief rally” with increased demand and good volume, we will begin to implement our safety control stop exit strategy for growth stocks. As discussed above, bonds should be held and added to, even if their prices drop along with the stock market. At current prices they represent tremendous value and offer a very good possibility for appreciation in addition to the interest payments. However, even if they don’t appreciate, all you have to do is wait a couple of years until maturity. Plus, they are always very liquid.
Now more than ever, it is important to be the expert or hire one… and that’s where we can help. Our active hands-on approach to managing portfolios can help you manage risk and deliver returns. Call me for a free consultation today at (916) 925-8900.
Regards – Keith Springer