{"id":4618,"date":"2011-08-08T15:01:25","date_gmt":"2011-08-08T21:01:25","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=4618"},"modified":"2018-09-21T02:04:46","modified_gmt":"2018-09-21T06:04:46","slug":"u-s-sp-credit-downgrade","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2011\/08\/08\/u-s-sp-credit-downgrade\/","title":{"rendered":"U.S. S&P Credit Downgrade"},"content":{"rendered":"

 <\/p>\n

By now you have heard that ratings agency Standard & Poor’s downgraded the credit rating of the United States to AA+ from its vaunted AAA.\u00a0 Investors around the world seemed to take this opportunity and this moment to sell, sell, sell their equities.\u00a0 In fact, the Dow Jones Industrial Average closed down today 634.76 points, or a 5.55% loss.\u00a0 Similarly, the Standard & Poor’s 500 Index fell 79.92 points, or 6.66%.<\/span><\/p>\n

From multiple perspectives this sell off looks over done to me.\u00a0 Here’s why:<\/span><\/p>\n

    \n
  1. U.S. government debt actually traded up on the day, such that yields actually fell.\u00a0 This clearly makes no sense since a credit rating cut on this very same debt means that it is riskier and therefore less valuable; so yields should have gone up.\u00a0 Presumably there was a flight out of “risky” assets, like stocks, into safe assets, like U.S. government debt.\u00a0 Frankly, this is retarded and clearly so.<\/span><\/li>\n
  2. There are U.S. companies that retain a AAA credit rating – higher than that of the United States government’s sovereign debt – all of whose shares traded down today.\u00a0 Again, if this was some sort of “flight to quality” then why wouldn’t these shares have logically traded higher?\u00a0 Instead, the shares of these businesses were caught up in gigantic sales of things like S&P 500 futures, SPDRS, index funds, or just general panic selling.<\/span><\/li>\n
  3. Most U.S. businesses, the folks that issue those shares of stock that sold off today, did not have their risk profiles change because the U.S. government debt sold off.\u00a0 You can make the argument that the equity risk premium, the amount of extra return that stocks have to provide in order to induce you to take on additional risk beyond that of a bond, has increased.\u00a0 The thinking here is that the cost of equity is composed of: risk free interest rate + equity risk premium + specific risk of a company.\u00a0 The part of that equation that changed was the, now obviously incorrectly named, “risk free rate.”\u00a0 This rate was always taken to be the yield on a 10-year U.S. Treasury Note.\u00a0 Yet that risk free rate actually fell today.\u00a0 Not only that, but the stock market fell by 6.6% today; presumably because all U.S. equities became 6.6% riskier today<\/strong>.\u00a0\u00a0 But did U.S. businesses really become 6.6% riskier all in one day?\u00a0 Clearly not.<\/span><\/li>\n
  4. As of Friday the S&P 500 Index had a total market capitalization of $10,950.54 billion<\/a>, or basically $11 trillion.\u00a0 For those that don’t know “market capitalization” means the total equity value of the 500 companies that make up the index.\u00a0 That the S&P 500 fell today by 6.6% means that U.S. businesses are worth $722.735 billion less than on Friday.\u00a0 By comparison the yield for a 10-year AAA credit is 2.39% as of Friday, whereas the yield for a 10-year AA+ is 2.50%.\u00a0 The difference between these two, or 0.11%, is a proxy for the interest rate increase that the United States will experience because of its new credit rating.\u00a0 The United States has approximately $14 trillion of debt outstanding.\u00a0 So the interest cost on that debt went up on Friday by $15.4 billion annually.\u00a0 Look at the differences in the sell of of U.S. equities – $722.735 billion – vs. the increased interest costs on U.S. debt at AA+ – $14.5 billion.\u00a0 This would seem to suggest an equity sell off that is 46.9x larger than it should have been.<\/span><\/li>\n
  5. Only S&P downgraded U.S. debt while Moody’s and Fitch, the other two major credit ratings agencies, held the U.S. at its AAA rating.\u00a0 So the composite rating of the U.S. is still AAA.\u00a0 Furthermore, S&P only followed through on its credit ratings warnings first described in March.\u00a0 In other words, there was plenty of time for financial market participants to absorb and assess the potential effects of any downgrade.<\/span><\/li>\n
  6. The downgrade should trigger action by politicians to figure out a way to shore up the current and future finances of the United States.\u00a0 When will Republicans agree that taxes are too low<\/a> and consequently to a tax increase, for example?\u00a0 Or at least the closing of massive loopholes that allow U.S. corporations to effectively pay 0-5% in corporate income taxes.<\/span><\/li>\n<\/ol>\n

    At an intuitive level there is tremendous amounts of queasiness in the system, so the capitulation that I described as needing to happen has yet to occur<\/a>.\u00a0 Trust me folks, when the queasiness subsides it will likely be one of the best buying opportunities since 2009.\u00a0 Why?\u00a0 U.S. businesses remain in fairly good shape, unlike in the lead up to the Great Recession.\u00a0 Right now panic is being driven by the finances of the U.S. government which is a much smaller percentage of the U.S. economy.<\/span><\/p>\n

    Jason<\/span><\/p>\n

    [This post has been edited for typos, but not for content.]<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

      By now you have heard that ratings agency Standard & Poor’s downgraded the credit rating of the United States to AA+ from its vaunted AAA.\u00a0 Investors around the world seemed to take this opportunity and this moment to sell, sell, sell their equities.\u00a0 In fact, the Dow Jones Industrial Average closed down today 634.76 […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-4618","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/4618","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=4618"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/4618\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=4618"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=4618"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=4618"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}