What Does Downgrade Mean for Stocks?

Includes: AAPL, BAC, C, JPM, WFC
by: Brian Nichols

Standard & Poor's downgraded the U.S. credit rating to AA+ after the market closed on Friday, August 7th. Market panic is expected to follow this decision as we have never experienced a downgrade in the history of our country. The government has appeared surprised with various opinions of this decision. But has anyone asked the question if the United States deserves a top notch credit rating? Most would agree that we do not deserve this rating as politicians have shown no sign of a practical solution for our debt issues. If paying off debt is the issue then we are in trouble since most would be satisfied with the U.S. not accumulating additional debt.

These are uncharted waters that we have never experienced during the history of our country. So what does it mean for our economy? Is it more significant than what we understand or is it less relevant than what we are expressing? Once again, these are situations in which we have never experienced, making it difficult to judge the long lasting or short term effects from the downgrade of our credit rating.

The market has been anticipating this to happen after negotiations regarding the increased debt limit were wasteful at best. Last week, more than $3 trillion disappeared from companies listed on global stock exchanges as a result of market mayhem. On Thursday, August 4th, the Dow Jones lost more than 4% of its value which accounted for most of the near 6% in weekly loss. Friday reflected the way in which I expect the market to trade during the coming weeks, covering a 400 point range throughout the day.

Is it possible that this downgrade has already been priced into the markets? I still anticipate more selling as investors should demonstrate mass fear until the true effects of this downgrade are known. We cannot change what has occurred. All we can do is work hard to correct the issues that are present and try to have some faith in our government. Regardless of what I should do, I am still asking several questions with one being, how did this happen?

  • The second bailout of Greece really kick started this widespread panic and speculation. It also caused us to realize just how bad the global market really is, which made us reminisce of 2008 when our economy nearly experienced a depression.
  • Investors began selling Italian, Spanish and other European Bonds which almost always causes rates to increase. This sparked more fear into investors and rating agencies.
  • Politicians demonstrated their inability to provide any logical plan to cut our deficit of more than $14 trillion.
  • Our "plan" only accounted for cuts of $2 trillion when rating agencies wanted a number closer to $4 trillion over a number of years.
  • Democrats and Republicans were incapable of putting behind there differences to address a debt issue that could now weigh on our economy

The meaning of this downgrade is that the agency does not believe our government can repay its debt. The agency has good reason to feel this way since our politicians seemingly could not get this deal completed, and were not happy with the end result. Analysts estimate that the new rating will cost our government an additional $100 billion annually. Citizens have voiced their concerns, saying this could lead to higher interest rates, including rates for such items as mortgages and college.

I expect treasury bond investments to decrease during the short term as confidence within our nation is at an all time low. In addition to investor confidence I believe this change could affect consumer confidence. Consumers are not confident in our nation or their job security and as a result will spend less.

In the end politicians' individual agendas prevented them from dealing with the issue of the debt ceiling in a proper way. They could have handled this problem much better and developed a plan that is attainable. We can not change what has happened. We can only try and move forward. We held this rating for much longer than we deserved. It would be equivalent to an American citizen with $500,000 in debt trying to get a $100,000 loan on $75,000 of income. While that is a metaphor it somewhat describes our government's situation except our government does not make payments on its debt.

With all the negative news it is hard to find a bright spot. Oil has dropped under $87. This will lower the price of gasoline and if the price could remain consistent it could provide a positive reaction to our markets. With lower gasoline prices consumers will dine out, purchase more merchandise, and take vacations.

Whether or not the market's current position is good or bad depends on your personal goals. If you are trading for short term goals then you will probably see more loss and it may prove to be a good idea to cut your losses. If you are a long term investor then this market could offer the advantage of purchasing stock at a cheap price. I do not believe we are headed toward another economic recession as in 2008. The difference between now and 2008 is company performance. Most of the major corporations have reported earnings and income that have increased along with strong guidance for the future. In 2008 the large companies were losing money and reporting less revenue.

Unemployment rates decreased slightly but are still considerably high. My opinion is that we are yet to adjust to a job market that has changed. With online consumerism these companies are now capable of producing the same level of revenue with fewer employees and less real estate. This is only one of the many issues we face but I see it as a large issue.

The bottom line is that our credit has been downgraded and our market is probably going to overreact. I expect the market to sell on Monday but I would not be surprised to see another day such as Friday. The financial sector will probably get hammered throughout the week with significant losses in stocks such a Citigroup (NYSE:C), Bank of America (NYSE:BAC), JP Morgan Chase (NYSE:JPM) and Well Fargo (NYSE:WFC). This downgrade may affect financial institutions but not to the level that investors believe.

I suggest that a majority of the loss has been factored in the market. But more should be expected until prices reach a level that investors feel represent value. Investors should watch this week develop, and pay attention to the trends. I have already stated that I do not feel we are going to endure another recession such as 2008. But we are enduring a downtrend related to economic panic on news that we do not fully understand. Look for good opportunities because this downgrade may slightly affect our government but it barely affects the large corporations.

Apple (NASDAQ:AAPL) is not different today than it was two weeks ago but the price is much lower. This logic is a way that an investor should consider when looking at stocks. If you like a stock and feel it is undervalued then buy shares. The panic will end at some point and when it does stocks will see large gains. Investors with patience will be rewarded in the end, not the traders who sold out of panic.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.