The Day After The Downgrade

It was quite a day in the stock market, which plunged by -6.7% as measured by the S&P 500 Index.  Given the events of the day, I wanted to provide a brief update on the markets and portfolio performance.

I’ll begin with the bottom line.  portfolios ended up for the day.  Although gains for the day were modest at less than +1%, this result was favorable given the considerable downside pressure coming from stocks.  Portfolio gains were supported primarily by precious metals such as Gold (+3.3% today), Silver (+1.7%) and Agnico Eagle Mines (+1.4%).  U.S. Treasuries also posted another strong advance, with government debt reaching new highs across the yield curve including TIPS (+1.2%), 3-7 Year Treasuries (+0.6%), 7-10 Year Treasuries (+1.6%) and 20+ Year Treasuries (+3.2%).  As a result, the hedging strategies in place to protect portfolios against major downside stock market events had a positive net effect today.

One fact coming out of today was notable.  Given that S&P, which is one of the three major credit rating agencies, downgraded the United States from AAA to AA+, it might have been reasonable to expect that U.S. Treasuries would have declined substantially today.  Instead, they traded sharply higher. 

This highlights an important point.  The sell off in stocks today had little to do with the U.S. credit downgrade.  Instead, it had much more to do with the ongoing financial crisis in Europe.  Over the weekend and into today, European leaders worked to try and resolve what is a rapidly deteriorating situation in Spain and Italy.  Despite their latest efforts to address the problem, financial markets remain unsatisfied and are starting to become impatient.  Hence the sell off in stocks today and the move to Gold, Silver and U.S. Treasuries, which are all still considered safe havens during times of market uncertainty.  Highlighting the fact that Europe remains the key overhang for the market, European financial preferred stocks were down between -10% to -20% today alone.  These types of moves in preferred stocks are highly unusual and help isolate the source of market stress. 

As for the U.S. credit rating downgrade, it will likely continue to do its part to add to market uncertainty and volatility, but its impact is currently secondary.  However, any unanticipated fallout effects from the downgrade will likely only begin to become apparent after a few weeks or longer if at all.  I will be watching this very closely and will keep you updated if I begin to see such effects beginning to boil to the surface.

Looking ahead, the stock market is now well overdue for a meaningful bounce higher, as it hasn’t been this oversold since late 2008.  But the fact that it is oversold does not mean that it won’t decline further.  After all, it was also oversold when the S&P was at both 1250 and 1200 just a few days ago, and today it closed at 1119.  And any bounce higher in stocks will likely be short lived – perhaps a few days to a week or two at most – given the weakening global economic outlook and the ongoing financial challenges in Europe. 

The one caveat to this stock outlook is the potential for action by global central banks including the U.S. Federal Reserve (Fed) or the European Central Bank (ECB).  For example, if the Fed were to announce another round of stimulus (QE3) either at their FOMC meeting tomorrow or at Jackson Hole at the end of the month, this could be the catalyst for a new rally higher in stocks.  Another example would be unprecedented steps by the ECB to finally try to get ahead of the crisis in Europe.  Once again, I will keep you updated on any developments on this front.

In the meantime, the emphasis will remain on keeping hedging strategies in place including positions in precious metals and U.S. Treasuries in working to generate further portfolio upside amid stock market turbulence.  Taking the opportunity when it presents itself to selectively add high quality stock names that have been pulled lower along with the broader stock market sell off will also be a priority in the coming days.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

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