By Rebecca Ellis
MON, AUGUST 07 2023-theGBJournal |Like the UK, which is having a gloomy summer so far and no change insight, global financial markets have entered August with the possibility of storms on the horizon.
What provoked the change in the sunny market mood?
One of the main dampers of market sentiment was offered by the credit agency Fitch. On Tuesday, the agency downgraded the US’s long-term credit rating from the top-tier AAA to a notch lower at AA+. The exclusive group of countries to hold this coveted rating has now shrunk to nine.
This rating decision means the agency believes the US government’s ability to repay its debts has declined. In May the US agreed a last-minute deal to avoid a default which would have sent the global markets into mayhem. Some analysts estimate that if the agreement hadn’t been reached, global financial markets could have plunged by as much as 45%
“There has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” Fitch explained.
The agency also noted that government plans to improve long-term health care and Medicare will increase US debt levels.
This is not the first time the US has been downgraded. In 2011, S&P Global, another of the “Big Three” credit-ratings agencies (the third is Moody’s), slashed the US government’s debt-repayment score, triggering a sell-off in riskier assets and a bounce for Treasuries as investors sought out safe havens.
How has Wall Street reacted?
Fitch’s downgrade is a fresh source of uncertainty for investors. Fuelled by uncertainty following the pandemic and spiking fuel prices provoked by the Russia-Ukraine war, a steep rise in inflation had sent markets 35% lower by October 2022. While markets have recovered sharply from those lows, the Fitch downgrade put a damper on this resurgence, pushing the Nasdaq and the S&P500 2.6 % and 2.2% lower respectively.
Naturally, the US government did not agree with Fitch; even so, the ratings agency’s announcement has spooked investors.
Is this simply a reaction to bad news concerning the creditworthiness of the world’s biggest economy, or is it the start of a shakeout to remove the froth from the market?
Froth or complacency, neither boded well in in 2000 and 2007, periods of exuberant bullishness immediately prior to brutal market corrections. As we discussed in in our July edition, recent market performance may on the surface seem spectacular. However it is largely driven by the “magnificent 7” and a few close followers; the broader market is not booming.
Signs of serious and broad market weakness are now beginning to surface; these include companies filing for bankruptcy at the fastest rate since 2009, and commercial real estate developers struggling to gain access to capital as lenders become more conversative.
Coupled with a slowdown in venture capital as underlined by a 40% slump in financing for start-ups and entrepreneurs, the signs are that the sunny days are starting to fade.
Now we understand the weakness, let’s go back to the downgrading of the US government credit rating. The US government has tackled inflation by hiking interest rates and continuing to spend, to head off the impending disaster threatened by the COVID-19 pandemic. These heavy spending patterns are continuing to this day.
Inflation spiked in 2022, yet the pace of price growth slowed to 3% in June, fanning hopes that the central bank can rein in price increases without causing a recession, and could even begin cutting rates in the coming months.
This complex situation has divided economic experts. The more optimistic, including Jeremy Siegel and Paul Krugman, have recently said a recession is unlikely, while others including David Rosenberg and Jeremy Grantham continue to expect a downturn.
The horizon like the British weather remains very mixed. We need to prepare for the outcomes by using risk free assets that will avoid volatility while at the same time offering their most appealing returns in years.
Rebecca Ellis is Family office advisor, re@aktspartners.ch| Co-author Martin de Sa Pinto, Martin de Sa Pinto Research
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