I am quite sure most of you saw the fall of US and foreign stock markets today. The irony is that despite the US being downgraded to AA+ from AAA, US Treasuries actually rallied significantly and the dollar rose.
The reasons are blatantly obvious, as we have been continually pointing out. Bailouts don’t work when the problem is the convergence of excess capacity on a global scale, coupled with unprecedented leverage, and that leverage has only become worse over the last 3 years from a sovereign debt perspective. The investing public essentially ignored the downgrade today, opting instead to focus on the real problem of slow to no growth, and mounting sovereign debt issues in Europe. The truth of the matter is that “Keynesian” economics is not a “modern” concept. The Romans used it as they saw the need to expand upon their empire without having the actual gold and silver to coin and barter with, so they decided that Caesar’s inscription on a lead coin was just as valuable as precious metals, since the “full faith and credit” of Rome was behind it. We all know how that story ended. There is still time for the US to avoid the same fate, but not for Europe, we believe.
The only remedy is a default or “restructuring” of much of the sovereign debt that is outstanding in Europe. The US can still avoid this inevitable problem facing Europe, but only if we, as Americans, choose austerity now. It’s already too late for them, and our research shows the Euro as it exists now, will not survive.
Although the downgrade was probably necessary as a “wake up” call for fiscal sanity, it was wrong from a standpoint of whether or not the ability of the USA to pay its debt has diminished. It has not. Where was Standard and Poor’s during the hyperinflationary period on the 70’s when the US printed and inflated its way out of that problem? Where was Standard and Poor’s during the subprime mortgage and derivative meltdown in 2008? This was a political move and a reaction to our political system, which is still the best on the planet. Regardless, the result will most likely lead to significant austerity measures as we have been predicting, and that is not good for stocks in the short run.
Our research indicates that although there may be a bounce due to technical “oversold” conditions, it is quite likely we will see stocks continue to decline, unless some sort of new intervention scheme to kick the can even further down the road is perpetrated upon us, only to fail and make it worse in the future. We need to see US large cap stock valuations between 7 to 10 time earnings on a trailing twelve month basis before we believe there can be a sustainable and lasting move upward. Valuations at that level have always marked the turning point for long-term secular bear markets. Currently, the market is trading at 15 times earnings according to, of all companies, Standard and Poor’s.
As of the market close today, the S&P 500 has declined almost 18% from its April 29th high, and is now down over 10% year to date.
Defending capital remains our primary focus, in order to take advantage of the next, sustainable leg up.
Please don’t hesitate to call in order to discuss your portfolio.
Thank you, again, for your trust and confidence.
John Brotherton, CFP®