Why Investors Needn't Worry About U.S. Credit Downgrade
The United States saw its credit rating downgraded for just the second time in history, but experts aren't worried about the long-term damage to stocks.
An exceedingly rare downgrade of the U.S. government's credit rating sparked a selloff in stocks Wednesday, but experts say any longer term fallout for both the equity and debt markets should be muted.
To recap: after the stock market closed Tuesday, Fitch Ratings cut the United States' long-term foreign-currency issuer default rating by one notch to AA+ from AAA. The credit ratings agency also removed its negative rating watch on the U.S. and assigned a stable outlook in its place.
Fitch cited a "high and growing general government debt burden" and the "erosion of governance" as reasons for cutting the government's rating.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
"The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management," Fitch said in a statement.
Fitch's downgrade represents only the second time in history that the U.S. has seen its credit-worthiness marked down. Standard & Poor's (SPCI) took the once unthinkable step of cutting the federal government's long-term credit rating back in August of 2011. S&P's move came after a prolonged fight over raising the debt ceiling put the U.S. in danger of a technical default on its financial obligations.
In that regard, Fitch, which is one of the so-called Big Three credit ratings agencies along with S&P and Moody's (MCO), is sort of late to the game, experts say.
Credit downgrade doesn't mean much
Bearish strategists wonder if the Fitch downgrade will finally break the market's feverish momentum. The Nasdaq Composite is up by more than a third on a price basis so far this year, while the broader S&P 500 has added about 18%. The blue-chip Dow Jones Industrial Average, for its part, has gained roughly 7%. Such remarkable returns are divorced from economic fundamentals, bears contend, meaning it's only a matter of time before our cyclical bull market comes to an end.
"The big news is the knock-on effect of the Fitch downgrade has exerted on the risk-on trade," writes David Rosenberg, founder and president of Rosenberg Research. "This is what it took to shake the market out of its complacency?"
Rosenberg adds that Fitch's downgrade means "any further prospect of fiscal juice for the U.S. economy is off the table."
Be that as it may, most economists and strategists are taking a more sanguine view of the situation. And there's certainly some comfort to be found in historical precedent. After all, S&P cut the federal government's credit rating a dozen years ago to no obvious long-term deleterious effect.
"The downgrade should have little direct impact on financial markets as it is unlikely there are major holders of Treasury securities who would be forced to sell based on the ratings change," writes Goldman Sachs Chief Economist Jan Hatzius. "S&P downgraded the sovereign rating in 2011, and while it had a meaningfully negative impact on sentiment, there was no apparent forced selling at that time."
Besides, the way in which federal debt is classified at the institutional investor level makes worries about forced selling overblown, the economist says.
"Because Treasury securities are such an important asset class," notes Hatzius, "most investment mandates and regulatory regimes refer to them specifically, rather than AAA-rated government debt."
Perhaps most importantly, the Fitch downgrade doesn't tell investors anything they didn't already know.
"Fitch's downgrade mainly reflects governance and medium-term fiscal challenges, but does not reflect new fiscal information," Hatzius writes.
What did stocks do last time?
Perhaps some solace can be found in looking at what stocks did the last time this happened. S&P downgraded the United States' credit rating on August 5, 2011. The broader market was volatile, trading mostly sideways for the next couple of months, until it bottomed in early October. The S&P 500 lost about 8% over that span.
Have a look at where the market stood six months after the downgrade and you'll see a much more chipper chart. The S&P 500 was up about 12% on a price basis at that point. One year after the downgrade, the market had tacked on 16%.
As for the really long view, in the nearly 12 years since the last time the U.S. caught a credit downgrade, the S&P 500 has generated an annualized total return (price change plus dividends) of 14%. That's pretty great. For context, over the past 50 years the market generated an annualized total return of less than 11%.
The bottom line is that while the Fitch ratings cut is by no means good news, it should hardly top the list of things keeping long-term retail investors up at night.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Dan Burrows is Kiplinger's senior investing writer, having joined the august publication full time in 2016.
A long-time financial journalist, Dan is a veteran of SmartMoney, MarketWatch, CBS MoneyWatch, InvestorPlace and DailyFinance. He has written for The Wall Street Journal, Bloomberg, Consumer Reports, Senior Executive and Boston magazine, and his stories have appeared in the New York Daily News, the San Jose Mercury News and Investor's Business Daily, among other publications. As a senior writer at AOL's DailyFinance, Dan reported market news from the floor of the New York Stock Exchange and hosted a weekly video segment on equities.
Once upon a time – before his days as a financial reporter and assistant financial editor at legendary fashion trade paper Women's Wear Daily – Dan worked for Spy magazine, scribbled away at Time Inc. and contributed to Maxim magazine back when lad mags were a thing. He's also written for Esquire magazine's Dubious Achievements Awards.
In his current role at Kiplinger, Dan writes about equities, fixed income, currencies, commodities, funds, macroeconomics, demographics, real estate, cost of living indexes and more.
Dan holds a bachelor's degree from Oberlin College and a master's degree from Columbia University.
Disclosure: Dan does not trade stocks or other securities. Rather, he dollar-cost averages into cheap funds and index funds and holds them forever in tax-advantaged accounts.
-
Stock Market Today: Stocks Waver on Resilient Employment Data
A private reading on payrolls had markets rethinking rate-cut bets just days ahead of the monthly jobs report.
By Dan Burrows Published
-
Lamb Weston Stock Gains After Earnings Beat, Layoff News
Lamb Weston stock is higher after the french fry maker reported earnings and unveiled a restructuring plan that includes job cuts. Here's what you need to know.
By Joey Solitro Published
-
Income-Investing Picks for a Recession
Investing for Income Some consequences of an economic downturn work to the benefit of fixed-income investors. Here are three fund ideas that fit the bill.
By Jeffrey R. Kosnett Published
-
Dogs of the Dow Are 2022's Best in Show
dividend stocks Some of the best investments for income investors in a volatile 2022 have come from the Dogs of the Dow.
By Jeffrey R. Kosnett Published
-
Bond Values in a Volatile Market
Investing for Income While the market's instability may not be over just yet, the latter half of the year should be less daunting – and possibly more rewarding – for investors.
By Jeffrey R. Kosnett Published
-
Should You Buy Bonds Now? What To Consider
bonds The fixed-income market has been turned on its head in recent years, but there are still opportunities for those looking to buy bonds again.
By James K. Glassman Last updated
-
Dividend Dates: A Beginner's Guide
dividend stocks Everything you need to know about ex-dividend dates, dividend announcements and other parts of the dividend calendar.
By Charles Lewis Sizemore, CFA Published
-
Income Investors Should Look Beyond the Ukraine Invasion
stocks Unless you invested in a Russian-themed ETF or an emerging markets index fund, the destruction of Moscow's capital markets is a distraction for investors.
By Jeffrey R. Kosnett Published
-
Consider Short-Term Bond Funds
Investing for Income These funds own the kind of stuff that benefits from a healthy economy and can withstand the Fed's rate hikes.
By Jeffrey R. Kosnett Published
-
A Dynamic Duo for Yield in 2022
Investing for Income Investors should maintain core positions in both REITs and utilities, with regular contributions to both.
By Jeffrey R. Kosnett Published