What The S&P Downgrade Means For You

| August 8, 2011 | 0 Comments

The week was done.  The market’s had taken a beating, but we made it safely into the weekend without a complete market meltdown.  In fact, the Dow even managed to eke out a slight gain on Friday after a 4% drop on Thursday.

Then it happened…

Early Friday evening Standard & Poor’s dropped an atomic bomb on the markets.  The rating agency issued the first ever downgrade of the United States’ sterling triple-AAA credit rating.  They lowered the once seemingly invincible AAA rating by one notch to AA+.

And they’re maintaining a negative outlook… that’s agency speak for further potential downgrades ahead.

As you might expect, the move is roiling markets this morning.

The Dow’s down 2.7%.  The S&P 500 is about 3.3% lower.  And the Nasdaq is off by more than 3.4% early on.

It certainly looks like we’re in for another big down day in the stock market.

Many of you are probably wondering what the downgrade means to you and your money.  While only time will tell how the markets will ultimately react, here are a few things to watch out for.

First off, the downgrade is likely to send stock prices significantly lower. The market hates uncertainty.  And the downgrade deals a major blow to already fragile investor psyches.

Stock markets have tumbled over the past two weeks as the economic picture darkened.  The Dow’s lost about 10% of its value, the S&P has shed nearly 11%, and the Nasdaq is off by more than 14%.

Investors around the world are clearly worried the US is falling into a double-dip recession.  And for good reason…

The latest GDP data show the US economy is growing much more slowly than everyone thought.  Consumer spending is falling off a cliff.  And despite a better than expected jobs number on Friday, unemployment remains stubbornly above the 9% level.

Now add to these woes a credit downgrade of the world’s most productive economy and you can see why investors are shaking in their boots.

Many investors are worried the downgrade will hasten the US’ fall into recession.

The theory is the US government will have to pay higher interest rates going forward to entice investors into buying more US Treasury debt.  And these higher rates will in turn drive up interest rates on everything from mortgages to consumer loans to borrowings by businesses.

Of course, higher interest rates make it tougher for the economy to expand.  Consumers tend to spend less when the cost of financing purchases moves higher.  And businesses usually borrow less and less as rates climb.

Exactly the opposite of what we need to keep the economic recovery on track.

Given the increased risk of another recession, don’t be surprised to see stocks move a lot lower over the weeks and months ahead.

Now, you’d think the credit downgrade would impact US Treasuries the worst.  If interest rates are heading higher, it makes sense US government bond prices would drop.

But the ongoing sovereign debt crisis in Europe is likely to prop up bond prices for some time.

You see, despite what S&P is saying about the quality of US debt, most investors still believe US Treasuries are the safest place to park their money.  No market is more liquid and more stable than the US Treasury market.

But this is probably just a short-term phenomenon.

Once Europe gets their house in order, the focus will likely return to the US government’s debt woes.  If the government hasn’t made any serious headway on deficit and debt reduction by then, we could certainly see US Treasuries move lower.

The one bright spot in the markets is Gold.

The shiny metal has been moving steadily higher since the financial crisis began in the fall of 2008.  Seen by many as the ultimate hedge against all kinds of risk, gold has been one of investors’ favorite places to hide.  And this time around shouldn’t be any different.

So, what’s it all mean?

Unfortunately, it’s just too soon to draw any conclusions about how the credit downgrade will affect markets longer term.  There are too many variables with potential to change at a moment’s notice.

With that said, we’re probably looking at a steeper and more protracted downturn in the stock market.  Treasuries are likely to move higher in value short-term as investors move in seeking shelter from the storm.  And gold is poised to make serious gains as investors flee to safety.

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Category: Bonds

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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