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Don't Panic: The U.S. Credit Downgrade Changes Nothing

Posted: 08/07/11 04:40 PM ET

After the S&P downgrade of U.S. debt, America now carries a rating of AA-plus instead of the coveted AAA rating on its Treasury bonds. Austria, Norway, Germany and Australia are no longer our peers ratings-wise -- we are, instead, in the company of Japan, China, Spain, Taiwan and Slovenia.

Market watchers have suspected a downgrade was in the works for a while. Not to toot my own horn, but last week in my column about 5 ugly truths about the debt ceiling, one of my takeaways from the deal was that a credit downgrade was in the works regardless of the fact we avoided default. Looks like my prediction, and the prediction of other financial journalists who made the same call of a credit downgrade, didn't take long to come true.

But now that the inevitable has happened, what does it mean for the market and for regular Americans with 401ks and IRAs?

Interestingly enough, not much. Washington is still useless. The stock market will continue the correction that began two weeks ago. And Treasury bonds, strangely enough, will remain a safe haven for investors.

Why This Doesn't Change the Narrative in Washington

S&P ain't breaking any news here. Its reasons for the downgrade include "political brinkmanship" in Washington. "America's governance and policymaking becoming less stable, less effective and less predictable than we previously believed," said S&P. It went on to say $2.1 trillion in cuts "fell short" of the needed reforms. Shocking revelations, I know.

While the downgrade is not to be taken lightly, it's just a confirmation of spending problems that have been slowly eating away at the creditworthiness of America for some time. And for those of you who think this will shake our fat cat legislators by the lapels and wake them up... well, just look at the quotes that emerged over the weekend. Predictably, the GOP blames the Obama administration for the downgrade -- with Sen. Jim DeMint even calling for Treasury Secretary Timothy Geithner's resignation. The Democrats are pointing fingers, too, with those pesky Tea Party extremists to blame for everything.

Sorry America, but the downgrade is just the latest development in this asinine game of chicken that Congress is playing to decide the White House in 2012.

Why This Doesn't Change the Stock Market Outlook

And that outlook, in case you've been living under a rock, is ugly.

The state of the stock market was already grim last week before the U.S. credit downgrade - and got worse after Thursday's gut-wrenching slide that marked the worst decline since 2008. All told, we have endured an 11% rollback in the S&P across the last 11 trading days as investors headed for the hills.

So the biggest question isn't how much the S&P downgrade is going to affect the stock market on Monday, but how many dominoes will continue to fall as part of the broader crisis of confidence. The downgrade surely won't help -- but it's just one more log thrown on the fire that is already burning pretty darn hot.

Why This Doesn't Change the "Safe Haven" Status of Treasury Bonds

The U.S. credit downgrade shouldn't have much of an impact on the perceived security Treasury bonds provide. Why? Well, consider the alternatives out there right now.

Stocks? CDs that barely keep pace with the rate of inflation? Corporate bonds or muni bonds that rank even more poorly than the "AA plus" ranking Standard & Poor's now applies to Treasuries? Not likely alternatives, any of these.

Investors haven't stopped buying T-Notes lately, and shouldn't on Monday morning. Just take a look at Friday's news that the 10-year Treasury yield dropped by the largest amount in one week since 2009. In the last month alone, yields on the 10-year T-Note has plummeted from 3.2% to a bit over 2.3%.

Those aren't exactly junk bond rates. If folks were shunning Treasuries than the government would have to entice investors with bigger yields to offset the perception of bigger risks. Yes, the downgrade means that T-Notes are riskier than they were before. But relatively, they are a much safer bet in the minds of many investors considering this difficult economic environment.

Of course, there's always Canada to invest in... or move to.

Jeff Reeves is the editor of InvestorPlace.com.Write him at editor@investorplace.com.

 

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