Credit Rating Agencies: No Use Betting Against Uncle Sam

Recently, there has been plenty of news regarding the potential credit rating downgrade on the United States.

Is this potential downgrade worrisome? Yes. Is this going to end the current bullish trend? Not too much, in our view.

(Case point: one can just check Berkshire Hathaway (BRK.A) stock movement after Moody (MCO) downgraded Berkshire last time --- the stock did not go down that much).

Here is why:

As we said before in our previous blog post:

The U.S. (as well as other cash-strapped developed countries) economic recovery will mimic emerging markets' economic recoveries.

It is a well-known fact that the U.S. relies more and more on cash-rich emerging economies to finance U.S. deficits and bailout packages. If many key cash-rich emerging countries were to decide that they are too busy dealing with their own internal economic problems and want to reduce their exposure to U.S. dollar-denominated assets, then the U.S would be at significant risk of running large fiscal deficit problems with lack of financing sources that could lead to rapid devaluation of their currencies and further reduce attractiveness for emerging countries to invest in U.S. assets.

Hence, it is true that U.S. is certainly at high risk of being downgraded by major credit rating agencies from AAA now to one level below it; this action could potentially reduce general valuation of U.S. dollar-denominated assets including real-estate assets.

However, consumer confidence level (a white-horse indicator in our view) is getting increasingly higher -- this is a good sign for consumer spending; if this trend continues, then U.S. markets overall may surprisingly go higher from current level despite all the negative fundamental facts of the U.S. economy as the markets may be more flexible to forgive current bad data for much rosier data in the future (market participants become more forgiving and more forward-looking).

Also, the fact that several major financial companies have been able to raise capital via private and public markets' offerings is a real-world proof that the bullish trend has legs. Intelligent investors should gauge the valuation level of current level with historical valuation of bear markets in the past 100+ years --- the current S&P 500 index valuation based on capitalization weighted-core earnings and adjusted for inflation appears to be on the low side.

What does it mean? It means the markets may still be undervalued and have significant upside potential from current level.

We are also more bullish on America as a country with great political system and entrepreneurial culture with unmatched desire to keep innovating. AAA or AA, it does not matter in the long-term as long as the U.S. keeps innovating and doing the right things to encourage entrepreneurship.

We also consider recent news about potential downgrade as just a lip service to show some kind of independence from the credit rating agencies. After all, these agencies were the ones that incorrectly rated many of the toxic mortgage backed securities before. Their credibility is questionable.

In addition, if U.S. government officials start to call these agencies "to discuss reasoning behind potential downgrade", we are sure these agencies will comply to whatever the U.S. government wants them to say to the public. Whether people like it or not, the Unites States is now in a much more regulated, more socialistic form of capitalism.

Therefore, there is no reason why the U.S. government will not use its mighty power to influence S&P (MHP) and Moody's decisions. Is it the right thing do? Not in a free market (but are we still in totally free markets in the U.S.?); But is it possible? Yes.

Do you want to bet against Uncle Sam? Similar to Warren Buffett, we do not.

Comments

[Vienna:]

From an European point of view, we always consider that the US is more dynamic and will recover faster.
As from the capitalistic point of view, this will enable us to get over the crisis.
Due to the ratings and possible further decline of the economy, I do think that the coming upward movement in time to come will be much slower, but giving the notion that the articles are more bearish than bullish, I would agree that this is not the end, only a change.
I am glad to see that a portion of socialism has moved to the US. This is now giving over 5 mio people a possibility to survive, and will not cause major poverty.

May 26 05:40 AM

[Gtarras:]

My personal read of the SA publishing/commenting crowd is 80% negative vs. 20% positive. Being in the "green" camp, I actually welcome that from a contrarian standpoint, but frankly was surprised to see this piece after all that crapola on SA site about US losing AAA rating. It is so out of fashion to be positive on anything US related nowdays..


On May 26 05:40 AM Vienna wrote:

> From an European point of view, we always consider that the US is
> more dynamic and will recover faster.
> As from the capitalistic point of view, this will enable us to get
> over the crisis.
> Due to the ratings and possible further decline of the economy, I
> do think that the coming upward movement in time to come will be
> much slower, but giving the notion that the articles are more bearish
> than bullish, I would agree that this is not the end, only a change.
>
> I am glad to see that a portion of socialism has moved to the US.
> This is now giving over 5 mio people a possibility to survive, and
> will not cause major poverty.

May 26 09:28 AM

[tuj:]

"From an European point of view, we always consider that the US is more dynamic and will recover faster. "

So why is the Euro trading at such a premium to the USD? The 1.4+ levels really are a bit unreal.

May 26 10:09 AM

[henarl:]

What we really need is someone with the authority and credibility to establish ratings that apply to S & P, Moody's and Fitch. Problem is; NOBODY has any credibility today!

May 26 02:09 PM

[Donald R. v...:]

Kamakura Risk Information Services May 26, 2009 has these 1 year default probabilities on display: UK, 0.71%; USA 0.50%, and Japan at 0.43%. Donald R. van Deventer

May 26 02:45 PM

[User 428400:]

How stupid a credit rating agency would be in lowering the credit rating of the United States. The U.S. would be in danger of default only when it starts issuing debt in foreing currencies, otherwise it can always run the presses and pay its debts.

Jun 09 11:38 AM