US Stocks down sharply on S&P downgrade 


Just when we thought the market had set a low for 2011 (last Friday's close,) one more piece of bad news rocked US and world markets.

Standard & Poors, which has rated US debt at AAA since rating first debuted in 1947, announced late Friday night that the agency was lowering US debt by one notch to AA+. These countries still retain AAA ratings: Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, Hong Kong, Isle of Man, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland and the United Kingdom. Greece is the sole CC or "junk" rated country. About 65 countries have no rating at all.

The significance of the move is primarily psychological as the US clearly has no risk of default in the next few years. The problem, of course, is what happens after 2015. At a certain point, the interest burden on debt becomes so large that it's impossible to repay (the situation Greece is in today.)

As of 11 AM EST, the risk trade was "off." Investors sold stocks worldwide, commodities in general, but bought gold. Perversely, investors also bought the dollar and short term treasury bills and notes. All that cash has to be parked somewhere, and the US treasury market is still the largest and most liquid in the world.

Stocks were a good value Friday evening and are a better value today. We added to stock positions over the last two weeks, and will add more this week. Key reminder about our strategy: For clients who need cash in the next 1-12 months, we either hold cash or short term government securities. No yield, but also no risk that the money won't be there when you need it. Our clients who receive an automatic monthly draw from the portfolios receive those funds from short term government bonds, which we will reload when stocks are higher. For clients who need money in the next 1-5 years, we have those funds reserved in corporate bonds and preferred stocks. For investment needs beyond 5 years, we have those funds in stocks and stock mutual funds. Sure it's frustrating to see US stocks give up ten months of gains (we're back to October 2010) in ten days, but the current reaction is way overdone to the downside. Of 5700 major companies traded on the NYSE and NASDAQ, 5250 traded down today. We call that a "capitulation day" when investors vomit up every stock they own.

Once "short covering" kicks in (investors buying back stock positions sold short in the last few weeks), we expect a short term rally, then some backing and filling while investors regain their composure. Some overlooked good news: Interest rates remain near 60 year lows. Oil is down from $115/barrel (West Texas Int.) on April 29th, to a current $83.88/barrel, which is an instant tax cut for car dependent Americans. US corporations are healthy, even if the US government is not.

We received quite a few phone calls and e-mails over the weekend, wondering about strategy. We will NOT sell stocks in the current panic, just as we refused to be panicked in any number of crises over the last few years. We continue to move cash into stocks where a client's situation justifies the risk.