What just happened?

Fitch, one of the major credit rating agencies, has downgraded the long term sovereign rating of the United States by one notch down from AAA (best in class) to AA+ (proximity to best in class). The agency has cited America’s steadily deteriorating fiscal position over the past 20 years and chaotic governance that leads to these imbalances as rationale behind its decision. The agency appears to be concerned about rising debt levels and political polarization that has lately become prevalent in the country’s financial decision-making process.

About 12 years ago, it was Standard & Poor’s (S&P Global), who arrived at the same conclusion while downgrading the country’s sovereign rating in a similar manner. Back then monetary policy makers had an unusually easy policy stance when ZIRP + QE (Zero Interest Rate Policy as well as Quantitative Easing) were both on full-blown mode! This time, however, the policy regime is different (higher rates and quantitative tightening). To make things worse, today policy makers do face some credibility issues as it has been obvious that policy mistakes can have rather adverse repercussions. For instance, even as of late 2021 when inflation was raging on, the Fed was in still in denial, somewhat detached from reality as Chair Powell insisted that inflation was transitory, a claim that did not age so well as it was followed by one of the harshest periods of rate hikes in decades disrupting the extreme complacency that preceded this tightening cycle! A series of regional bank failures took place earlier this year as an offshoot of the unusual nature of the policy pivot. Nevertheless, equity markets are unusually buoyant again with some minor exceptions so far this year. Market reaction was sharp in 2011, when the broad market shaved off ~18% within a few months around the rating downgrade (including the debt-ceiling drama in July that preceded the downgrade in Aug of 2011).

 

Context:

It was only a few months ago when the Congressional Budget Office (CBO), a nonpartisan agency that keeps an eye on the financial books and accounts of the United States, has warned the public that the US Govt is potentially on the verge of a technical default unless the debt ceiling was raised soon. The market had by and large ignored the warning as a background noise as heightened imbroglio has become a common place occurrence in financial decision-making process in the US in the post-GFC era. Events that take place around the debt ceiling negotiations, for instance, reveal that lawmakers are somewhat blatantly comfortable in brinkmanship and politicization of critical issues that can have potentially destabilizing impacts on the system. No wonder, Fitch finds that this process is no longer acceptable behavior for a AAA credit worthy client!

Post-GFC, each crisis has paved the way towards new rounds of aggressive stimulus measures by politicians and policy makers. On the Conservative side, major tax cuts have been enacted in the recent years while on the Center-Left side, generous fiscal handouts have been offered to the general public with the logic that low interest rates require negligible debt servicing costs (… as if low interest rates are a given fact for eternity!). The US debt burden has spiked up over threefold from below 10 Tn USD to over 31 Tn USD since the GFC. In the meantime, side effects of the Covid-19 shock stimulus became obvious as inflation spiked up and monetary policy had to become stringent in response. As fiscal outflows increased relative to growth, despite having one of the strongest labor markets in history (aka increased government revenue in the form of strong tax collection), deficits remain at a historically high level while debt servicing costs have soared in the recent past.

Our current base case is that given the unusually strong market sentiment at present, risk-assets would most likely shrug-off the Fitch rating decision in the near future until some other extreme form of side effects resurface. The downgrades by S&P and Fitch are simple corroborations of an existing problem that has been brewing for quite a while now, rather than an emerging problem by itself. The market has been accustomed to living with it, although the impact of systemic shocks tends to get worse over time, and so does the periodic consternation of extreme market reactions to such tail events.

 

How is Altfest incorporating this into investment strategies for our clients?

It is hard to time exactly how and when such adverse effects of long-term imbalances may manifest themselves in mildly negative market reactions, and when they get unraveled in disorderly extremes. As such, our preference is to incorporate considerations of short-term and long-term factors both on macro and micro fronts in our portfolio construction process as we believe markets always converge to fundamentals over a reasonable period of time.

Our recent move of duration exposure from unhedged to hedged long bonds proved to be timely, and serves as a good example of Altfest’s contrarian thinking. In addition, while there are good reasons why precious metals are depressed today on a relative value basis compared to the past, we have been actively monitoring this space for potential entry points. In addition, any pickup in broad market volatility may pave the way to strengthen our equity positioning for the long term.

 

How does this impact you?

A credit downgrade of US debt can have various implications for individuals, the broader economy, and financial markets. The US government’s credit rating reflects its ability to repay its debt obligations, and a downgrade signals that credit rating agencies have concerns about the government’s creditworthiness. However, it’s important to understand exactly how this may impact your portfolio or retirement plans before taking any action.

To schedule a complimentary consultation with our team please use this link to find a convenient time. During our consultation we will take the time to thoroughly understand your situation, family dynamic, lifestyle and financial positions against the backdrop of your personal, professional and financial goals to assess weaknesses and opportunities. This assessment may span from your investment portfolio to areas like taxation, estate planning, insurance / risk management, etc. to provide you with a holistic and comprehensive assessment. The advantage to you is that you’ll know that no stone will be left unturned and there will be no unpleasant surprises in the future. The real benefit is the peace of mind that comes from having a team of professionals at your side during good and bad times so you can always be comfortable with your finances.

 

Investment advisory services provided by Altfest Personal Wealth Management (“APWM”). All written content on this site is for information purposes only. Opinions expressed herein are solely those of APWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.