Fitch Downgrades U.S. Debt
- Fitch downgraded U.S. debt from AAA to AA+, citing concerns around debt levels.
- The timing of the downgrade is strange but could lead to less volatility than S&P’s downgrade in 2011.
- Risks remain in markets, and we expect more volatility in the second half of this year.
Yesterday, Fitch Ratings downgraded U.S. debt, sending bond yields higher and equities lower. Though timing is a bit strange, this downgrade now adds another concern for investors, adding to elevated valuations, economic uncertainty, and a potential Federal Reserve policy mistake. While the news of the downgrade is concerning, we have 2011 as a guide, as this isn’t the first credit rating agency to downgrade the United States. Based on the last downgrade, we expect this new downgrade will likely increase market volatility. However, better- than- expected second- quarter corporate earnings and a resilient U.S. economy will likely offer some type of downside protection.
On concerns around the impact of rising interest expense and increased government spending, Fitch Ratings downgraded U.S. debt from AAA to AA+. Specifically, Fitch cited, “The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.” Besides the United States, Denmark is the only country with a debt process requiring agreement from political parties to raise the debt limit, as the constitution requires.
As a result of the downgrade, financial markets are now pricing in higher risk, as the yield on the 10-Year U.S. Treasury rose to its highest level since last November, equities are lower, and the VIX, a measure of market volatility, is higher.
We mentioned the timing is strange, since the debt limit was signed into law on June 3. It took nearly two months after this issue was resolved for Fitch to downgrade U.S. credit. They did cite growing debt levels, but the current “last-minute resolution” was resolved. While the timing is peculiar, it may be better than 2011 when Standard and Poor’s downgraded the U.S. amid the debt ceiling debate, causing more volatility. Waiting to issue the downgrade after the debt ceiling negotiations may create less volatility this time around.
Typically, bond investors do not put a large weight on credit ratings, which tend to be stale and outdated. They tend to have their own internal ratings, independent of rating agencies. One could argue this downgrade is long overdue and outdated. S&P downgraded the U.S. over ten years ago and the reasons Fitch cited in the downgrade were old news. Bond investors have been aware of these concerns for many years, so the concerns mentioned in the downgrade are unsurprising, and bond investors should have largely accounted for them already.
Looking back at 2011, S&P downgraded the U.S. on August 4, 2011. Again, this was in the middle of the debt ceiling debates adding to already heightened tensions. The S&P 500 sold off around 7.5% in just a few days but was above the level it started in less than two weeks. We would expect volatility to be less this time around as it isn’t the first time we have seen a downgrade, and the timing is better. However, as mentioned earlier, this is just another reminder of market risks, which have been climbing a wall of worry, as the old Wall Street adage goes. Furthermore, one potential limit to the market downside could be earnings, which have been surprisingly strong for the second quarter, with over 82% beating expectations so far.
We think a recession is still possible over the next 12 months, but we think it could be a mild recession. A strong labor market and service economy could hold up the economy as companies adjust to higher interest rates. Markets could be volatile; however, we do expect market fluctuations. We reiterate our recommendation for increased diversification. Please continue working with your financial professional to help you align your portfolio with your long-term investment objectives. Creating a financial plan you can monitor and follow helps avoid distractions and stay focused on what you can control.
About Cetera® Investment Management
Cetera Investment Management LLC is an SEC registered investment adviser owned by Cetera Financial Group®. Cetera Investment Management provides market perspectives, portfolio guidance, model management, and other investment advice to its affiliated broker-dealers, dually registered broker-dealers and registered investment advisers.
About Cetera Financial Group
“Cetera Financial Group” refers to the network of independent retail firms encompassing, among others, Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Investment Services LLC (marketed as Cetera Financial Institutions or Cetera Investors), and Cetera Financial Specialists LLC. All firms are members FINRA / SIPC. Located at 655 W. Broadway, 11th Floor, San Diego, CA 92101.
Individuals affiliated with Cetera firms are either Registered Representatives who offer only brokerage services and receive transaction-based compensation (commissions), Investment Adviser Representatives who offer only investment advisory services and receive fees based on assets, or both Registered Representatives and Investment Adviser Representatives, who can offer both types of services.
The material contained in this document was authored by and is the property of Cetera Investment Management LLC. Cetera Investment Management provides investment management and advisory services to a number of programs sponsored by affiliated and non-affiliated registered investment advisers. Your registered representative or investment adviser representative is not registered with Cetera Investment Management and did not take part in the creation of this material. He or she may not be able to offer Cetera Investment Management portfolio management services.
Nothing in this presentation should be construed as offering or disseminating specific investment, tax, or legal advice to any individual without the benefit of direct and specific consultation with an investment adviser representative authorized to offer Cetera Investment Management services. Information contained herein shall not constitute an offer or a solicitation of any services. Past performance is not a guarantee of future results.
For more information about Cetera Investment Management, please reference the Cetera Investment Management LLC Form ADV disclosure brochure and the disclosure brochure for the registered investment adviser your adviser is registered with. Please consult with your adviser for his or her specific firm registrations and programs available.
No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The opinions expressed are as of the date published and may change without notice. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision.
All economic and performance information is historical and not indicative of future results. The market indices discussed are not actively managed. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information.
Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries