Downgrade May Not Affect Institutional Treasury Holdings

by: Nigam Arora

On Friday, right after S&P downgraded the US debt I wrote an article, titled “U.S. Downgraded: What to Do Now”. As my long time readers know, I work very hard to get the data first, analyze the data under the rigorous, consistent, analytical framework of the ZYX Change Method, and only then make an actionable plan. I fully expected action items outlined in the article to be unpopular.

There is a considerable amount of research at The Arora Report as well as at other respectable research shops, that conclusively show extremes in sentiment represent turning points. Extremely bullish sentiment is a time to sell. Extremely bearish sentiment is a time to buy.

Most investors find it psychologically difficult to follow what the data says is needed to hit home runs. This is exactly where services such as those from The Arora Report and from others that are grounded in data provide most value to investors.

I had no intention to write another article at this time. However, as I keep tabs on what is being published I have become deeply concerned about the blatantly wrong information in the media regarding the laws pertaining to the downgrade. I’ve been patiently waiting for someone else to set the record straight. Unfortunately, this has not occurred.

Wrong Information That Is Being Spread

Pointing out that the vast majority of gurus are wrong about the law, especially when their opinions are popular, is not a pleasant task. Fortunately, my allegiance is with the investors and not with the gurus.

Below is the wrong information that is being spread:

  • Money market funds will have to sell US Treasuries.
  • Banks will be required by law to sell US Treasuries.
  • Insurance companies will be required by law to sell US Treasuries.

Correct Information About The Law

Here is what the law is:

  • While S&P cut the long-term rating, it reaffirmed the short-term rating for the US at the top A-1+ level. This means money market funds will not be forced to sell US Treasuries.
  • Most banks in the United States are regulated by the Federal Reserve Bank. The Federal Reserve has issued a crystal clear statement that there is no change in the risk weighting of US Treasuries. This means that the banks will not be forced to sell US Treasuries.
  • Most insurance companies in the United States are governed by state regulators. It is likely that state regulators will follow the lead of the Federal Reserve, and insurance companies will not be required to sell US Treasuries.
  • There are three primary credit rating agencies – S&P, Moody’s (NYSE:MCO), and Fitch. While S&P has downgraded the US debt, both Moody’s and Fitch have reaffirmed AAA rating of the US debt.
  • Bond issuers, as well as bond holders, are allowed by law to use the highest rating available if there is a conflict between the ratings of the agencies. This means that the United States, as well as holders of US Treasuries, will rely on the ratings of Moody’s and Fitch.

The Plan

I will be providing guidance in real time to clients and subscribers. If time permits, I will also provide some guidance on an ongoing basis on my blog.

  • We will stick with the plan outlined in my last article.
  • If stocks get hit, we will be buyers of the ETFs SPY, DIA, and QQQ.
  • If gold and silver spike up, we will short sell the ETFs GLD and SLV or buy ZSL.
  • We will take the opposite side of the first move in US Treasuries. We will use the ETFs TBT, TBF, and TLT.
  • We will be buyers of other assets if they come down to the price levels provided in advance to subscribers.

Disclosure: I am long QQQ, TBF. I am short TLT and silver futures.