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
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