Unfortunately, the outlook is grim if one dusts Friday's trading session for clues. U.S. stock indices rallied more than 1% at the start of trading Friday on a better-than-expected July employment report, retracing some of the 5% loss from Thursday.
Stocks fell anew, however, on market chatter that S&P was planning to announce a downgrade of its triple-A rating on U.S. debt after the closing bell. After briefly topping 11,550, the
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gave up its gains and fell as low as 11,150 shortly before midday, a swing of more than 400 points in less than three hours.
Stocks ultimately ended the day mixed, but if Friday's early swoon is any indication, Monday's trading session will see plenty of red. Matthew Rubin, director of investment strategy with
, says that investors may not have priced in the full extent of an S&P downgrade.
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"We could wake up on Monday morning and see the futures down precipitously, but I want to believe some of this was priced into the market," Rubin said by phone Friday after the S&P announced its decision to cut the rating on U.S. debt to double-A-plus from the coveted triple-A rating.
Jeffrey Sica, president and chief investment officer of Morristown, N.J.-based Sica Wealth Management, says that investors are not caught completely surprised by the downgrade, yet he still expects a "substantial selloff" in equities on Monday as market participants begin to understand the ramifications of the first downgrade of U.S. debt in history.
"We maintained the triple-A rating through the Great Depression and all the wars and recessions, so you have to believe it's going to concern people," Sica said by phone late Saturday. Investors were bracing for a downgrade all week, but "there will be a lot of fear and worry," he adds.
A late Friday downgrade announcement by the S&P was a premeditated move that was designed to allow investors to digest the news.
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"It is evident that S&P announced it without giving the U.S. equity market a chance to react quickly," Sica says. "It was designed to give investors a whole weekend to settle down."
That decision may backfire. Sica says anxious clients have been calling him nearly round the clock since the downgrade was formally announced around 8 p.m. EDT Friday.
"Investors are scared to death. There was an unbelievable amount of worry," Sica says. "People understand that this is bad, but no one knows what it means. The education process could be devastating."
While working over the weekend, Sica outlined what it means for the U.S. to lose the triple-A rating. The first item on his list was "confidence."
"There will be a loss of confidence, no doubt," he says. "That will manifest itself, maybe not in the quick overnight crash, but instead
in a slow declining ugly market. It'll decline more and more as it affects confidence in general."
One of the biggest reasons for anxiety is the possibility of future downgrades. S&P, which is a segment of
said the outlook on the long-term double-A-plus rating is negative, and the U.S. could suffer another downgrade within the next two years "if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case."
"This anxiety will stick with us for a very long time," Sica says, referring to the threat of future downgrades. "We could lose AA+ to AA relatively easy. Moody's could very easily look at this downgrade as prompting them. They gave a very dire warning about what they were willing to do in the future. It's going to shake a lot of people's confidence. Paralysis will take place."
Outside of equities, gold prices will likely keep marching higher, but the impact on nearly all other assets is uncertain. The bond market had been a popular hideout for investors throughout the drop in equities last week.
Throughout the debt ceiling debate and amid worries of a downgrade of debt by the credit rating agencies, the 10-year Treasury continued to rally, with the yield dropping to about 2.55%. Whether that flight-to-quality trade continues is anything but certain now following the downgrade.
Sica points out that many pension funds have mandates that will require managers to sell non-triple-A rated securities. Fitch and
continue to rate U.S. debt as triple-A, which may prevent the mass dumping of Treasuries, so any fears of an immediate collapse of the bond market may be premature. Still, Sica expects rates to move higher soon.
"Ultimately, there will be an incredible sale of Treasuries. Rates
rise," he says. "We're at the tipping point where people will begin to realize there will be a lot of selling pressure as buyers disappear. We've crossed the level of yield people will accept for risk."
There are plenty of other unanswered questions about the impact of the downgrade. Like President Obama, officials in China -- the largest holder of U.S. debt -- have been quiet on the downgrade. However, the Communist Party's
highlighted the risks and dangers to China and other economies because of the downgrade.
"They were very vocal the last few days saying this should be a lesson to the U.S. and their borrowing," Sica says. "Sure, AA+ isn't pristine AAA but it's the best of the worst. But yields are going to pop. Foreign investors will get out of dollar-denominated securities."
There also are questions about how the
will act. The Federal Open Market Committee will meet on Tuesday and issue a decision on interest rates. Chairman Ben Bernanke will hold a press conference after the decision is announced and will face hard questions from the media.
The central bank said Friday that the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities (GSEs) will not change. But there are murmurs now of another stimulus program from the Fed through another round of quantitative easing.
Sica says that the Fed is going to mull over some stimulus solution, but that a stimulus solution will not be welcomed as it once was.
"If the market does rally on a Fed stimulus solution, that's a time to sell into that initiative," he says. "I would use rallies to sell. Rallies will be on promises of more government stimulus programs."
There is also worry of how the downgrade will affect financial institutions, GSEs, insurance companies and public finance. Although the Fed and banks in general have attempted to reassure investors they'll be fine, Sica says the downgrade will have a real anxiety effect on banks in general.
"When the banks and insurance companies come out and say everything is OK, you have to run from them," Sica says. "They have no credibility. All the insurance companies and all the things that will be affected by the downgrades."
Finally, the next big worry for investors outside of the threat of further credit downgrades will be the role of the dollar as the world's reserve currency.
"That's the next conversation, and that will scare people more," Sica says. "This is an economy that created more jobs and opportunities for generations of people. It's incredibly sad it's come to this."
-- Written by Robert Holmes in Boston
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