By Stuart Katz, Chief Investment Officer Robertson Stephens
August 2, 2023 – Stocks continue one of their best years on record. Since 1927, this year ranks as the tenth best year through July 31st. The 2023 strength is supported in part by better-than-expected earnings and more evidence of a resilient US economy that may glide into a soft landing. If we lean on history, market returns were mixed in the final five months of each of the other nine years that posted better returns than year to date 2023. In the bucket of “known unknowns,” Fitch Rating Agency indicated earlier this year they were considering the possibility of a downgrade. Today, Fitch downgraded the US sovereign ratings from AAA to AA+, with a stable outlook. The rating agency’s explanation is outlined in the link below. At yesterday’s market close, Moody’s was at AAA and S&P at AA+ (S&P downgraded from AAA in 2011).
We believe the announcement is more likely to be dismissed than have a lasting negative impact on the US economy and the markets. However, it may be a signal to politicians in Washington that the capital markets are increasingly concerned with the recurring debt ceiling hostage negotiation shenanigans. When S&P downgraded the US in 2011, it was a concern in financial markets in part because many investment mandates were written that investment collateral had to be “AAA” rated. Since 2011, many investment contracts have been rewritten to include definitions such as “debt backed by the US Government”. As a result, we do not anticipate any forced selling in the marketplace. Ultimately, these contract obligations are backed by the US government, which recently demonstrated a commitment not to default. Generally, the lower a borrower’s credit rating, the higher its financing costs. As of mid-day Wednesday, Treasury yields advanced and stock markets fell as investors digested the ratings downgrade. However, credit default swaps (CDS), which insure exposure to US Treasury defaults, were little moved. Additionally, the equity market CBOE VIX index (“fear gauge”) increased to around 15%, which is its long-term average and still near the lows of the last 12 months. Finally, the US dollar rose based in part on today’s payrolls data showing the labor market remains resilient. Finally, gold prices (“flight to safety trade”) are roughly unchanged, impacted more by a stronger dollar and rebound in bond yields which create a greater opportunity cost to owning gold.
This market activity is more muted than S&P Rating Agency’s 2011 downgrade (first downgrade ever of US government from AAA rating) when investors sold equities and purchased Treasuries (price up / yield down).
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Disclosures
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