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TheStreet Open House

Downgrade Alone Won't Kill an Emerging Market

Stocks in this article: DJI ^GSPC ^IXIC

NEW YORK (The Street) -- While few investors are rushing to pour money into Ukraine bonds or shares, a major downgrade may not be the deciding criterium. 

To be sure, the greater likelihood of default captured in a poor credit rating is some reflection of the stability and quality of investments in that country.

Standard & Poor's downgrade of the Ukraine's foreign currency rating to CCC on Friday reflected the agency's view on the Ukraine's risk of default. "At this level we are saying they will likely default in the next 12 months if they can't secure external funding," London-based S&P analyst Ana Jelenkovic told The Street, stressing the move was an assessment of credit worthiness rather than investment risk. As if to illustrate her point, Ukraine bonds rallied on Friday on news of a peace deal between President Yanukovych and opposition leaders.

Elsewhere, Argentina illustrates the frequent disconnect between sovereign credit ratings and investment return. Its domestic stock market jumped 80% in 2013 and has returned another 10% so far this year. S&P has a credit rating of CCC+ on the nation with a negative outlook, citing increasing legal risks on Argentina's defaulted debt.

Last year, Argentina's stocks were fueled by signs of an economic recovery and the return of global risk appetite. But S&P's rating may well come home to roost for the South American republic this year, with analysts warning of a growing risk of renewed recession. That may matter little to punters who were lucky enough to call Argentina's rally last year, provided they read the tea leaves in time to cash out.

Generally, a foreign currency rating below BBB- means a nation has a higher risk of failing to meet its funding obligations. Countries which fall into this hallowed basket include Greece, Egypt, Cyprus, Jamaica, Lebanon, the Congo and Pakistan.

Another example of the disconnect was seen when the U.S. lost its prized AAA credit rating in August 2011 over wrangling around the budget deficit and debt ceiling. The U.S.'s credit rating was cut to AA+, triggering fears at the time of impact to the greenback's reserve currency status. But ratings are all relative. Few other nations had superior ratings at the time and the greenback held its reserve aura.

The short story: credit ratings are important, but assess investments on other merits before rushing to cash your Argentine shares.

-- By Jane Searle in New York

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