1) U.S. Downgrade is basically a ”Political Leader B#tch Slap” (one I think they deserve): Below is an excerpt from Standard & Poor’s (S&P) most recent Sovereign Default Study – the study most applicable for discussing US debt obligations. Notice anything concerning the difference between AAA, AA and A? This is an average cumulative default table – so on average, for instance, the 5-year cumulative default study for BBB-rated debt is 3.97%. THERE IS NO DISCERNIBLE DEFAULT FREQUENCY or frequency variation around any sovereign debt rated above A. Thus, S&P’s own study shows no default variation differential between AAA & A. The fact that the US is AA+ or A- is completely qualitative and arbitrary relative to historical default data. This means that the market will continue to view the U.S. as effectively AAA because the downgrade has nothing to do with statistics and models. BUT, it has everything to do with telling the U.S. Leaders that they screwed up so bad that a subjective over-ride of their debt rating model is warranted given the government’s inability to balance the budget, control spending (and its general failure investing money).
2) 10-year Treasury Yields of 2.4% are lower than Great Depression Levels: (and lower than historical averages), this is not sustainable. Investors still believe that the U.S. is the safest place to park cash and since the downgrade occurred this past Friday night yields have decreased, meaning more investors are buying U.S. government securities. I would not call it a vote of confidence, but it still shows that investors think the U.S. is here to stay and the downgrade is not about actual default probability but is more of a symbolic political message.
3) U.S. Equities Markets are Oversold and Price-to-Earnings (PE) Ratios are approaching historical average levels. Currently the PE Ratio for the S&P 500 on an inflation-adjusted earnings basis is approximately 19x. In other words, the pricing of publicly traded equities across the 500 companies in the index are trading at about 19 times their earnings. Historically, the average PE ratio for the S&P 500 is approximately 16x to 17x. We are very close to reaching that average if selling continues just a bit more. If corporate earnings continue to improve (and that’s a big IF) and at the same time pricing continues downward the PE ratio will be very much under the historical average in no time at all. In addition, the S&P 500 is currently trading below its 20-day moving average, which is another signal that things may be swinging upwards (not necessarily “straight up”, but at least in the right direction).
HOWEVER, One major caveat: This is of course dependent on further political debacles, if these continue then we will see Moody’s and Fitch follow S&P’s downgrade-lead and all hell will break loose. If reasonable steps are taken by the US government and European nations to assure investors of our respective nations’ ability to both pay our debts and contain inflation then my upside argument holds water. As events unfold this week I will update my analysis at www.NetWorthProtect.com.