Weekly Market Commentary 7-25-2011

Deficits, Defaults, and Downgrades

Tim Phillips, CEO – Phillips & Company

There are so many interesting things going on right now in the world, but if I wrote on anything other than the debt debate it would be like talking about baseball during football season.

I still stand by my forecast that we will have a debt deal although I too am getting very worried as the decision comes down to the wire. Although a debt deal may be reached, one unanticipated consequence of this debate will likely be an eventual downgrade of our debt rating. (Note the use of the word eventual as it might be years)

For years, we have been racking up annual budget deficit that make up our $14.3 trillion dollar debt.

Fiscal year (begins
10/01 of prev. year)

Value of
increase
$Billions

2000

18

2001

133

2002

421

2003

570

2004

596

2005

539

2006

575

2007

500

2008

1,018

2009

1,887

2010

1,653

In 2007, the deficit was a mere $500 billion and now we are talking about over $1.6 trillion.

The credit rating agencies have come out and said:

“We may lower the long-term rating on the U.S. by one or more notches into the 'AA' category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future.” - Standard & Poor’s

“Moody's considers the probability of a default on interest payments to be low but no longer to be de minimis. An actual default, regardless of duration, would fundamentally alter Moody's assessment of the timeliness of future payments, and an Aaa rating would likely no longer be appropriate”. - Moodys

By the way, these are the same jokers that placed Triple-A ratings on junk mortgages just a few years ago.

The interesting thing about the debate and the reaction from the credit rating agencies is they’re not talking about our ability to pay back the debt (the $14.3 trillion). Instead, they’re talking about our ability to shrink the amount of borrowing we take on each year and our ability to refinance that debt continuously. At the end of the day the "full faith and credit" of the United States Government is meaning a little less right now in the opinion of the credit rating mafia. This is a sad state of affairs.

Whether we talk about paying down the debt, shrinking the deficit, refinancing our existing debt or a debt rating downgrade, we’re facing one simple fact – higher interest rates. That's why I'm spending considerable time working on what works in a continuously rising rate environment. You saw some of that in last week’s blog.

As we face some pretty gut wrenching days ahead with tremendous market volatility, keep your eye on the horizon which is your investable time frame. If you have enough time, and that's relative for each of us, the volatility can be looked passed. What can't be overlooked is the reality that we are facing the proposition of much higher interest rates under almost every scenario and we need to prepare ourselves for that.

The one scenario where rates can stay low is if the Fed steps in with more open market activity. Remember the Fed can still buy and sell US Government debt. They simply can't sell new issued debt as that comes from the Treasury at the authority of Congress (the debt ceiling thing).

We appreciate all the feedback we get every week and I look forward to response throughout the week.

Tim Phillips, CEO – Phillips & Company

@PHCOAdvisors

tphillips@phillipsandco.com

Primary Research done by:
Adam Gulledge, Associate – Phillips & Company