BOSTON (TheStreet) -- Investors are in panic mode following the Standard & Poor's downgrade of U.S. debt, dumping equities and oil while buying gold and Treasuries, but the big investment banks are sweating the loss of the prestigious triple-A rating yet.On Friday, S&P lowered its long-term sovereign credit rating on the U.S. to AA+ from AAA and affirmed the A-1+ short-term rating, marking the first time the country's rating has ever been downgraded. S&P, which is a segment of McGraw-Hill ( MHP), said the outlook on the long-term rating is negative, and the rating could suffer another downgrade within the next two years.
"We believe the medium to long-term effects of the U.S. sovereign downgrade are minimal, even as the short impact (next two weeks) could be turbulent," Lee writes in a research note, asserting that the S&P downgrade itself has minimal medium/long-term impact. Lee says that JPMorgan fixed income strategists see a minimal immediate impact on 10-year Treasury rates, while the firm's economics team says that the change in sovereign rating has no effect on the expectation for gross domestic product, or GDP, growth in the second half of 2011. Lee also says the risk of downgrade to financial institutions as well as state, local and municipalities is limited. For most of the investment banks, the loss of the triple-A rating was not totally unexpected. Citigroup equity strategist Tobias Levkovich notes in a Monday research note that investing clients "have anticipated the ratings change already but that does not mean that markets will not react negatively to the actuality. Indeed, some observers believe that the market's selloff this past Friday morning was tied to speculation of a downgrade." In the context of what he says is government policy error, Levkovich says that market anxiety now seems justified, but investor sentiment is not as dire as some pundits would have you believe. "Further stock price weakness could cause a substantial shift in the mindset, but the current sense that the 12% correction over the past two weeks and allegedly attractive valuation already captures new economic/earnings concerns and does not appear to signal genuine fear within the investment community," he adds. Levkovich says U.S. large-cap stocks stand out as possible outperformers in the current market environment. "Indeed, with corporate margins likely peaking out and valuation being relatively attractive, the largest U.S. entities may begin to outperform after almost 15 years of underperformance," he says. Bank of America/Merrill Lynch analysts David Bianco and Priya Misra also believe the market had baked in expectations of a downgrade, although they argue the S&P's decision to cut the rating "further undermines confidence and credibility in an already fragile economy. This should keep the Fed accommodative for longer," they write in a research note Monday.
However, Bianco and Misra say that a muted bond market reaction would lead to a small but recoverable stock market decline. "We think it is very possible that stocks will stage a respectable 'on the new' rally this week provided fixed income markets simply stay orderly," they write, adding that their sector preference order is tech, energy, materials, industrials, financials, consumers, health care, utilities and telcom. Lastly, UBS economists expect that the Treasury yield curve will steepen and that long-term yields will rise by as much as 25 basis points with the next week or two. "The U.S. dollar probably will weaken against the safe-haven Swiss franc and Japanese yen but rise against the euro, pound, Nordic and commodity currencies," the UBS economists write in a research note Monday. "Risk premia are likely to remain high, and we recommend adding to high-quality corporate credits on days when they widen rather than chasing rallies. The financial services industry appears to have prepared well by boosting liquidity. Gold should benefit from strong flows." -- Written by Robert Holmes in Boston. >To contact the writer of this article, click here: Robert Holmes. >To follow Robert Holmes on Twitter, go to http://twitter.com/RobTheStreet. >To submit a news tip, send an email to: email@example.com.