Some good reading to end a topsy-turvy week.
Well, it’s finally happened. As Chinese mandarins fingered their mountain of U.S. Treasuries by flickering LED light and we soundly slept beneath U.S. nuclear bombers patrolling our skies, the S&P agency downgraded U.S. debt.
The decline from AAA to AA+ puts the U.S. on a lower rating than the UK as well as Liechtenstein, and on a par with New Zealand.
S&P said in its press release (reprinted by the WSJ):
We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process.
We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.
U.S. Treasury officials tried to head-off the downgrade by pointing out a $2 trillion error, amongst much else:
Treasury officials noticed a $2 trillion error in S&P’s math that delayed an announcement for several hours. S&P officials decided to move ahead, and after 8 p.m. they made their downgrade official.
From hedge fund traders buying Korean growth stocks to doomsters hunkering down with gold, everyone knew this was coming. For at least three years the question was been how best to respond to the deterioration of America’s finances, not whether it had happened.
As such, this should all be in the price. Indeed on Thursday I published a graph showing bond yields typically fall after a downgrade from AAA status, meaning bond prices rise as investors buy more of the downgraded debt!
There’s usually been a sell-off in such bonds beforehand, however. In this week’s market madness, U.S. bond yields had already shrunk in the flight to safety, pushing down yields.
There’s also the scary question of unintended consequences from the downgrade. Will the embarrassing shift to AA+ status also cause technical breaches in financial contracts? As I wrote last Saturday, some City insiders have considered the potential for a systemic event.
Downgraded portfolios, too
This blog doesn’t have the answer to a question on a million financial professionals’ lips. On the face of it though, the downgrade to U.S. debt looks ridiculous: This is the world’s reserve currency, from the world’s strongest nation, and nobody seriously fears Treasury holders won’t get paid.
True, some fear the U.S. will inflate its way out of debt – so you might get paid, but in much less valuable dollars. But according to S&P’s press release, its model scenarios put CPI inflation at 1.5% to 2%. So no Zimbabwean antics to blame there.
Even if the chances of a superpower that can print its own money not doing so to pay its debts seem close to zero, I don’t berate S&P for the downgrade. Whatever ratings agencies do, they’re kicked for it. Let’s remember it was U.S. politicians squabbling and posturing for their constituents and the chronic lack of both long-term thinking and honesty about the past that brought America to this juncture.
Another reason I’m not going to make any specific predictions: If I’d been more vague about my foreboding last weekend, I’d now be seen as a financial soothsayer!
The FTSE 100 fell 10% last week – one of the worst weekly performances of all-time – and the modest portfolio trimming I’d conducted beforehand was a pretty flimsy defense. My year-long defensive shift away from trackers pumped up on energy and cyclicals towards companies like Unilever and other income payers (together with more skeptical investment trusts like the Independent Investment Trust and others) served me well until Friday, when the levee broke, spreads widened, and my small cap and subscription shares cratered.
Regrets? Life’s too short, and selling out too expensive.
While it’s rare for me to be worried about the markets, churning your portfolio is a very costly insurance, even for more active investors like me, for whom bargain basement costs are intellectually sound but in practice fleeting.
A frictional cost of 2-3% or so may seem cheap compared to a crash, but markets don’t usually crash, and when they don’t the entire effort is simply an ill-judgement tax on your wealth.
There’s also the issue of when you buy back in. Most market timers miss the bottom.
Instead of regrets I’m glad to have the chance to buy more shares cheaply, especially at the more illiquid end of the spectrum. A focus on income helps, too.
If you’re young, then the markets hanging around at these levels for a few years will likely make you much richer in the long-run. The growing multiple of my portfolio against my annual disposable income is lessening that effect for me, but there’s always the dividends to reinvest and compound.
With the FTSE 100 on a current P/E of less than 10 and a forward P/E around 9, I don’t expect us to stay down here for long.
Here’s a list of crash-related articles, to be devoured or driven-by as you desire:
- The brokers with their hands on their faces blog – TBWTHOTFB
- US stocks reconnect with ‘six bear’ average – Money Moves Markets
- Market turmoil presents opportunities for bargains – FT
- Europe: Rearranging the deckchairs – The Economist
- Felix Salmon: How stocks react the macroeconomy [They crash!] – Reuters
- Smurfs are a danger to capitalism – Ian Fraser
- Protect your emotional capital in a crash – Quint Tatro
- Think 1938, not 2008 – The Reformed Broker
- Thanks a lot, Europe [On Confidence in the Eurozone] – Fortune/CNN
- Relief at US debt agreement will shift to alarm [Prescient!] – FT
Now onto our usual weekend reading fare
From the money blogs
- Why passive investors aren’t really lazy – Canadian Couch Potato
- How to find the right kind of growth – UK Value Investor
- Three scenarios for the UK economy – The IMF Blog
- Who ate all the gilts? – Stock Tickle
- More funds does not mean more diversified – Oblivious Investor
- Turning money management into a game – Get Rich Slowly
- How to find extra time to make more money – PT Money
- The economics of self-fulfilling beliefs – Stumbling & Mumbling
- Paul’s DIY rumour builder – Paul Kedrosky
Mainstream media investing articles
- Does (US) healthcare coverage make people healthier? – Slate
- Join the ISA boom! – The Motley Fool
- The scary Japanese ‘Lost Decade’ graph [Graphic] – Business Insider
- Innovative building society mortgages for first-time buyers – FT
- More buy-to-let deals coming out, too – FT
- Structured products of dubious utility touted in the FT – FT
- Make money renting your home for the Olympics – FT
- John Lee’s takeover-friendly portfolio – FT
- Pension statements are overly optimistic – Telegraph
- Boomerang children cost parents £3,500 a year – Telegraph
- Gold price tracks the U.S. debt ceiling – Telegraph
- Dividends shine in low interest rate era – Independent
- Sadly, the West has hit its credit limit – Independent
- How to become a successful freelance – The Guardian
Want a reading list every Saturday? Subscribe! (It’s free).
Comments on this entry are closed.
This makes interesting reading today!
http://www.topyields.nl/Top-dividend-yields-of-FTSE100.php
@noiseboy – Yep, there seemingly some bargains about. I’d caution against just looking at the top yielders though.
Here’s the first of my articles about buying a portfolio of high yield shares: http://monevator.com/2007/09/05/grow-your-income-with-dividends-from-high-yield-shares-part-i/
I’d still fancy the high-yield portfolio I bought back in May for new purchasers: http://monevator.com/2011/05/06/a-new-high-yield-portfolio-for-2011/
Your recent sojourn in southern Europe had reassured me. Here at last was credible action – or so I thought – to resolve this eurozone ‘crisis’. I was wrong.
Ha ha. Yes, the Monevator wall of
money only stretched so far…
Be interesting to see what happens to US treasury yields now the rumour has been confirmed as news.
On the face of it the S&P downgrade seems absurd – does anyone really believe that the US is more likely to default than the UK or France – but I sense the fear is not so much can’t pay as won’t pay. When the debt ceiling was introduced it was to force a limit on the costs of WW1, but it now serves as a bargaining chip between America’s deeply divided political parties. It should have been abolished long ago, but now it serves as an obstacle and delaying mechanism for really serious decision making on debt reduction.
I remember reading somewhere an interesting suggestion that no sovereign debt should be rated AAA in the 21st century – it creates a false impression of watertight security where none exists and encourages financial complacency. Now that would be a constructive move from the ratings agencies.
Was there ever a part 4 to your series on investment trust subscription shares? I’m guessing a significant market slump might make for an opportune time to be investing in these.
@Faustus — You’re right, I was snapping some subs up on Friday. Perhaps I’ll get onto it this week. The trouble is I never did the evaluation a particular issue post.
Agree re AAA. Market stability fuelled macro complacency fuelled market instability (a minsky moment!) reveals government impotency!
Right idea last saturday then but wrong bat stroke… caught out by a legwork at the crease as Geoff Boycott would say… take a big stride forward!
If you’re going to trade, trade… as George — the man who broke the bank of England — Soros says ‘no trade is too big if you’re right’… Different doing to thinking it I appreciate but I don’t recollect Monevator every being bearish in my years of reading (3? 4?) so… perhaps sometimes you should trust your instinct?
Thoughts from one who has been there… !
@OldPro – Agreed, but I’m very much more an investor than a trader, even in the past couple of years when I’ve been more active than ever. Yes, this time to sell down aggressively (at least in the ISA-d holdings, where tax and paperwork isn’t a worry) would have been the best move, but I’m very wary of the 2-5% turnover cost of being wrong!
I’m a much better bull than a bear, at least until the next dotcom boom equivalent comes along. I don’t think markets crash on bad macro news, fundamentally. They crash on toppy valuations, and I just don’t see that, especially not in the individual shares I hold. (Maybe in commodities / miners and energy / government bonds).
Having only really started my passive portfolio at the start of this year (other than a lump sum in an L&G FTSE100 tracker ion April 2009) this is the first time I’ve seen a significant drop in value.
Starting to understand the various comments that the hardest thing to get right in investing is your own emotions.
I have thought about what the future may hold in Europe and beyond and whether I’d be best with a stack of cash in a bunker
Then again, I hear the words from Omaha, be greedy when others a re fearful and fearful when others are greedy.
However, I’m fundamentally lazy, and didn’t sell anything or buy anything as it was just too much hassle to change my monthly direct debit and the lump sum minimum amounts are just too high to be messing around with.
Maybe thats the key to successful passive investing – being lazy, plus choosing a platform that makes it as difficult as possible to do any trading.
I think I’m going to stop reading the news as well (but not this blog)
@ Ben – on the brightside, your going to be buying your units cheaper now so more units for the same money – the bright side of a slump.
Question for you is whether you want to, and can afford to, diversify your holdings.
My holdings are reasonably diverse already, US, Europe, Japan, Pacific, UK All Share, UK FTSE250 and emerging markets. Plus gilts, cash and NS&I RPI certificates.
A step on from my original FTSE 100 tracker effort. Mainly due to stuff I picked up from this site.
I’m happy to be buying more units at lower cost and will continue to cost pound average rather than try and time anything…
anyone trying to be a bit more active out there?
My apologies, Ben – I misread your first post as you having the whole lot in L&G FTSE100.
I’m not being any more active than usual but that’s partly down to lack of cash flow.
If I did have a lump sum, I would be buying defensive blue chips at the moment. Since I don’t have a lump sum, I’m increasing the amount going into my Lindsell Train funds, no other changes at the moment – to early to make any decisions for me.
Times like these that prior diversification into ‘boring’ assets like defensives, gilts or even cash suddenly seems sexy. In contrast I’m reafing reports of private investors seeing their focussed portfolios of a handful of oil explorers, small caps and the like fall 40% or more in a week! 🙁
@Ben – Absolutely. If you’re a new investor, this sort of experience is invaluable. First you’re buying more stuff cheaply with new money now. Second, better to learn how fast and hard a crash hits when you’ve not got so much to lose than when you’re say 60 and at the tail end of a secular bull market, too complacent or even greedy (in investment terms) to diversify.
I feel most for 50 somethings who have to manage a treacherous stock market in peak earning years only to have to rebalance as they age into more correlated asset classes and lousy fixed interest yields.
This is small fry so far, we’re just back to this time last year.
Great article as usual – just wish I had more spare cash on the sidelines to drip in. This is the first time I’m not too fazed by the drops – I’m basically invested to produce an income stream rather than capital growth – the plan being to use some of this income from ISAs and SIPPs in a few years time. If I was looking for capital growth to buy an annuity I would be much more concerned.
I do wonder how much of these drops are caused by computer driven trades (and speculators) I did jokingly once suggest that all trades should have to be made using the post – that way no-one could invest over less than a weeks time horizon !
Keep up the good work
Peter
@Peter – I read the other day that 60% of current trading is algorithmic, but that doubtless includes a lot of high frequency trading volume. I definitely agree it feels like a trader’s market, rather than that long-term investors are evaluating the risks and rewards.
(I don’t say that because its gone down – long-term investors can just as easily decide a market is too expensive and sell-off – but because of the volatility, which it’s hard to believe is really being driven by evaluation of company’s future earnings!)
@monevator
regardless of whether trades are made by a computer or by a person, over the long term its difficult to see how a market index couldn’t represent the underlying value of the businesses that comprise it.
If that is true then whether you think its a traders market or not is based not on any globally acknowledged truth but on your own relative viewpoint. This viewpoint will be closely tied up with how often and the reasons for why you trade.
So if you have been buying up shares based on short term volatility over the past few weeks, it will look like a traders market. If you haven’t it may look like a long term investors market.
Theres just one market – but with many peoples perception of it…
@Ben — Oh, absolutely agree regarding the long term. Dividends and earnings per share drive long term share prices. I don’t even mind if traders sell off irrationally once a year to give me cheap shares.
I do think it’s useful — if you’re a more active investor like me — to have a view of what is driving short term prices though. I don’t believe price discovery is completely inefficient so if a company’s share price falls it might make a difference to me if it’s a momentum driven robot selling versus a value investor who has spotted something I’ve missed.
Passive investors are best off ignoring all the noise and this speculation, and investing through highs and lows if course.
p.s. @Ben — Anthony Bolton just put it more clearly than I did in this FT article: