Weekly Market Commentary 8-8-2011

More Questions Than Answers

Tim Phillips, CEO – Phillips & Company

As I discussed in our blog post last week about Deficits, Defaults, and Downgrades, we believed a downgrade was inevitable, but thought it would come to fruition much further down the road. At this point, there are plenty more questions than answers, but here is my insight into this unprecedented downgrade. Please remember there has never been a downgrade in United States History, so much of what I have to say should be taken in that context.

The likely short-run impact on US debt will be limited and muted. I suspect we will see effects to the magnitude of 25bp-50bp. Going from AAA to AA+ doesn’t mean much in terms of the government’s ability to pay. However, the negative outlook, if not removed and if other rating agencies follow suit, we may soon see much higher interest rates.

This situation is really more about prodding the political class to resolve the problems we all know exist in our country: entitlement spending, our debt, the deficit and tax policy.

There could be a significant impact on municipal debt with many downgrades to come. Any debt attached to federal spending or with US agency backing would likely see some deterioration.

Banking Sector

This sector was predominately sparred from the Fed, suggesting holding AA+ debt is the same as holding AAA debt. We shouldn’t see bankers running for the exits. Where would they run to anyway? France? Bermuda? New Zealand?

Corporate Sector

Insurance companies may have a tougher challenge to overcome based upon their charters, prospectuses and covenants. We’ll have to watch this sector closely. Companies in general might need to make some investment policy changes or dump their treasuries if they don’t have rating flexibility. This could pose a problem.

The Fed

As I have been suggesting, the Fed will likely enact some kind of easing policy to push banks into lending and stimulate the economy. This might become more challenging if the Fed attempts to buy the debt from the banks and issues new debt with a lower rating at the same old price. My guess is the banks are going to want better returns at some point in exchange for buying slightly worse debt. That in turn may cause banks to hold the debt with higher yields and not lend. So much for quantitative easing. Let’s see if the Fed can successfully navigate this situation.

Political Class

The real benefit is our politicians just got a cow prod up their you know what’s to resolve systemic problems with government spending habits. As they do this with the Budget Control Act which passed last week, we might actually see much more stability brought back to our markets once the committee makes its big cuts. This is to be done before Thanksgiving.

The Consumer

Assuming rates don’t jump through the roof, which I don’t expect to see in the near future, the consumer is not in too bad of shape.

  • RevPar, the average price a consumer pays for a hotel room, is rising. This only occurs when rooms are being rented, suggesting a very good sign for consumer consumption and confidence.
  • Furthermore, same store sales growth are rising 3-5%+.

My suggestion is to prepare for volatility and review debt holding in detail with your financial advisor. Also, if you have the time horizon to do so, make strategic investments in the coming months.

If the consumer is in as good of shape as the data suggests and this debt debacle is really about political posturing, then as Washington resolves these issues this could mark a historic buying opportunity.

This is speculation on my part and there are many more questions than answers at this point. Stay tuned to see how this all unfolds and what it might mean for you.

If you have any other questions about the downgrade feel free to contact me.

Tim Phillips, CEO – Phillips & Company

@PHCOAdvisors

http://www.facebook.com/phillipsandco

Primary Research done by:

Adam Gulledge, Associate – Phillips & Company