I have to disagree with my friend Colin Lokey about the United States' sovereign credit quality. In an article on S.A., he cites Sean Egan, president of Egan-Jones, a rating agency, as follows:
"The key measure on sovereign credit quality is debt-to-GDP, in the case of the U.S., it's risen rather dramatically, from four years ago at 75 percent debt-to-GDP, to currently over 104 percent."
Colin agrees with Egan and seems to agree that Egan-Jones should have downgraded the U.S. He also concludes that a useful resolution of the fiscal cliff will not be good for U.S. stocks.
I beg to differ. If the President and Congress can pull off a reasonable compromise, I believe it would help the economy and stocks greatly.
The U.S. Borrows in Dollars, Not Euros, Rubles or Yen
First off, however: The U.S. is not like Greece or Spain or any other country that borrows in a currency that it does not control. The rules are different for a country that borrows in its own currency. Such a country-including the United States-need never default. It may suffer inflation by reason of issuing too much debt, and it may, at the same time, have to pay high rates on its borrowings because its currency's value is shrinking relative to other currencies or hard assets. But it need never default. And since a credit rating is an estimate of default probability, not an estimate of whether a long-term interest rate is sustainable, the U.S. should have the highest rating available, whatever that is, regardless of the relationship between its debt and its GDP. (Debt-to-GDP is a pretty simplistic measure. But that is beside the point.)
It is true that the U.S. could voluntarily default on its debt. And some people think that could happen. They think that the Tea Party Republicans are stupid enough to visit that horror on the American people. I think the Tea Party is an extreme movement that often does not understand the logical consequences of its own positions or proposed actions. But I do not think they are stupid. Nor do I think the Republican Party wants to commit hari kari by forcing the United States to default. The smart people in the G.O.P. will have seen from this week's election that the American public prefers centrist rather than extreme positions. See this good story in the FT, for example.
Compromise and Beyond
That is not to suggest that the road to compromise will be easy. The Tea Party and its allies will emerge from the presidential defeat angry and determined to prove that theirs is the true path. Compromise therefore will come only after posturing, threats and anger. But compromise of some sort there will be, and if it is a reasonably good one, then that development will join with
- rising employment,
- gains in housing prices and housing starts,
- and the benefits to GDP and employment that repairing and improving homes and infrastructure damaged or threatened by Hurricane Sandy will bring in at least the first two quarters of 2013 (see my article here),
to create a better sense of economic well-being in America than we have seen since 2006.
The Aging Bull Market
The Bull market that began in March 2009 is somewhat aged. But it has, so far, been built on two factors: (1) corporate profits via a shift in share of income from labor to capital and (2) low interest rates. If improving employment, an improving housing market, and an improving economy can join those factors, the bull could still have many months to run.
So please don't dump your SPY and your well-managed mutual funds. And please don't sell your equity portfolio down to the bone. Stay at least 50% in equities so you can take advantage of the opportunities that may lie ahead in the first half of 2013. There are no guarantees, of course, but the upside potential is there despite three and half years of gains. What else are you going to invest in?