Breakout

America’s Downgrade: One Year Later

Jeff Macke
Breakout

A year ago this week marked the beginning of arguably the worst period for American markets since the darkest days of the financial crisis. The depths of the European mess were just becoming known, our economy was demonstrably slowing, and a shameful debt-ceiling debate threatened to shut down the government.

The selling parade started on Friday July 29, 2011 when the Commerce Department announced that second-quarter GDP came in at a disappointing 1.3%. Even worse, the first-quarter growth rate reduced from a somewhat respectable 1.7% to 0.4%, uncomfortably close to zero. Stocks weathered the damage for the moment but the ice was melting under its feet.

The following Sunday, July 31st, Congress reached a complex deal designed to bring an end to the humiliating debt ceiling showdown. The gist of the deal was that the ceiling was hiked immediately and paid for with savings to be determined in the future. Markets were unimpressed. Driven by the ineptitude of our elected officials and an endless drumbeat of bad news in Europe, stocks fell more than 7% during the first week of August, closing out on August 5th at 1,199 on the S&P500.

All of which was before Standard & Poor's took the unprecedented action of downgrading the credit rating of the United States from AAA to AA+. "The political discourse has diminished the credit standing of the United States," said S&P's John Chambers. The rating agency may have been overreaching from a strictly financial sense, but was ideologically spot on.

S&P released word of the downgrade that Friday after the market closed. If the goal was to let traders digest the move and make calm decisions when trading reopened after the weekend, it didn't work. That Monday, August 8th started weak and got worse from there. The S&P 500 had fallen 6.6%. The lows for 2011 were made the next day at almost exactly 1,100.

From the close of trading on July 28th to the bottom on August 9th, the S&P 500 lost 15%, the Dow Jones Industrial Average 13.7%, and the Nasdaq 15.6%. It was far from the worst seven days of trading in market history but it was as bad, as hopeless, as anything since the 2009 lows.

We may not have forgotten what happened a year ago, but we seem all but condemned to repeat it. The flimsy deal President Obama announced last July was contingent on a compromise being reached between both parties in a Super Committee. Failure of this committee led to mandatory spending cuts to be imposed at the beginning of 2013. In effect, the debt ceiling debate was pushed into 2013, and has since been re-dubbed the Fiscal Cliff.

The problems are much the same but the markets have adapted. At 1,380 the S&P 500 is up nearly 10% for the year and a whopping 25% from the bottom of August 2011. Odder still, the U.S. 10-year treasury yield has dropped almost 50% since the downgrade. To Lee Munson, author of Rigged Money, the appeal of U.S. debt transcends ratings agencies.

"Even though we're a bit tarnished because of the amount of spending going on in Washington, we do have the best brand," Munson says. The U.S. economy withstood stagflation in the 1970s, the Japanese scare of the 1980s, the Tech bubble of 2000, and the financial meltdown in 2008. The illusion of a Fiscal Cliff isn't going to wreck us now.

"We're taxing like a small government, but we're spending like a large government," says Munson summarizing today's situation nicely. Politicians don't admit it but Munson says even Washington insiders realize there's no hope of setting a fiscal plan between now and at least the middle of 2013.

The solution, when it comes, is going to hurt everyone as Munson sees it. For all the howls to the contrary, nothing currently on the table is likely to destroy the republic. Any firm plan beats meandering into insolvency while yelling at one another, which is what America has been doing for the last several years, at least.

"I would not expect the same type of gridlock that we've had for the last several years to continue," concludes Munson. "Quite frankly the American public is just not going to stand for it."

Neither will the markets. If we're having the same conversation this time next year, stocks will be far below anything we saw in August of 2011.

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