After a week of massive declines across global financial markets, the stage was set for more selling pressure in Europe and on Wall Street as stock exchanges in Asia opened earlier this morning with bouts of panic selling.
Japan’s Nikkei 225 average fell 1.4% in early trading.Middle Eastern markets, which trade Sundays, reacted with swift sell-offs. Israel’s Tel Aviv stock exchange dropped 7%, while in Egypt, stocks fell over 4%.
The catalyst: a late Friday downgrade of the United States’ AAA credit rating by Standard & Poor’s, followed by the credit agency’s weekend warning that further downgrades could come if Washington remains mired in political gridlock over solving the nation’s long-term debt woes.
The USA‘s first-ever downgrade could raise borrowing costs for government, business and consumers. For already skittish investors, it’s just the latest in a string of jolting bad news: lingering high unemployment, a widening European debt crisis and eroding consumer confidence in the economy and political leaders.
S&P Managing Director John Chambers, who took part in the credit-rating decision, told USA TODAY Sunday that while the size and growth of the U.S. government’s debt were behind the downgrade, politics factored in even more heavily. Leading up to the Aug. 2 deadline for a debt ceiling deal that could have led to the USA defaulting on its debt, S&P put the government on credit watch and warned last month that the odds of a downgrade at 50% within three months.
S&P’s credit watch committee decided to announce the downgrade after Wall Street’s close Friday to give investors time to digest the news over the weekend, says David Beers, head of S&P’s debt rating unit.
Igniting a bear market?
Mounting fears of a looming debt default already had put the brakes on the stock market’s 2011 climb. The selling pressures gained steam in the days after an 11th hour deficit-reduction deal between Congress and the Obama administration that seemed to please no one.
The S&P 500, an index encompassing the biggest blue-chip corporations, has plummeted 12% the past two weeks — exceeding the 10% drop that unofficially marks a correction — and shows little sign of bottoming.
Moreover, economists and market strategists are unsure whether the economic headwinds and deepening debt crisis point to a soft patch in the economy or a more protracted double dip recession that many fear will derail consumer spending and corporate profits.
“No question the economy has slowed. But for investors, does that mean this is a correction in a cyclical bull market or something more severe — the start of a bear market? I wish I knew,” says Hugh Johnson, a veteran market strategist who manages a $2 billion portfolio.
Bear markets are declines of 20% or more. Wall Street hasn’t had one in nearly 2½ years.
“With fingers crossed, I say this is a soft patch and transitory,” Johnson says. “But it’s a close call.”
Nigel Gault, chief U.S. economist for IHS Global Insight, now says the chance for recession is 40%, up from 20% in June. “Recent trends look perilously close to stall speed for the economy,” says Gault, citing a lack of job expansion, a slower economy, Washington’s political wrangling over how the $14 trillion deficit and the looming debt crisis in Europe.
“For the past few months, there’s been a competition between Eurozone and U.S politicians over who can mess up the most,” Gault says. “I don’t think a winner’s been decided yet. The spectacle over the debt ceiling in Washington was very damaging to consumer and business confidence. That the government could let the U.S. go to the brink of defaulting on its obligations is disturbing for rational grownups.”
Late Sunday, the European Central Bank said it would “actively implement” buying government bonds, a move that could help alleviate concerns about debt-strapped Italy and Spain and bolster Europe’s financial markets. The ECB also urged Spain and Italy to implement quick reforms to cut their deficits and shore up their economies.
More political rhetoric
Solving the USA’s financial woes could prove far more difficult for gridlocked Congress, which is on recess until after Labor Day.
Weekend reaction to S&P’s credit rating downgrade ignited little more than a fresh round of partisan finger-pointing and spin control.
Republicans blamed President Obama for failing to consider major changes to costly entitlement programs such as Medicare, Medicaid and Social Security. Democrats accused conservative Tea Party elements of the GOP of sabotaging a larger debt-reduction plan that could have averted S&P’s credit downgrade.
“This is essentially a Tea Party downgrade,” says David Axelrod, a top Obama political adviser. “The Tea Party brought us to the brink of a default.”
Republicans are firing back.
“Unfortunately, the president and the (Democrat-led) Senate have always been unwilling to put a specific plan out there to address entitlements,” says House Budget Committee Chairman Paul Ryan, R-Wis.
The downgrade could put increased pressure on Congress to come up with additional deficit-reducing budget cuts and new ways to boost revenue. It has approved more than $900 billion in cuts spread over 10 years, and a bipartisan “super committee” will be charged with trying to find an additional $1.5 trillion .
Now, budget watchdog groups want that figure to double. “Maybe it’s the wake-up call we need,” says Maya MacGuineas, president of the Committee for a Responsible Federal Budget. “This may be that push that’s necessary to turn the super committee into something that’s really super.”
David Walker, former U.S. comptroller general and head of the Government Accountability Office, says the downgrade could prompt Washington to act. Still, he says, major changes to the tax code and entitlement programs may have to wait until after the 2012 elections. That’s because neither side is showing any signs of conciliation in the wake of the downgrade.
Republicans whose opposition to tax increases made a bigger deficit-reduction deal impossible say the downgrade still fails to make the case for tax increases.
“Republicans are Republicans. They will not raise taxes,” said Grover Norquist, president of Americans for Tax Reform, the group that convinced most Republicans in Congress to sign an anti-tax pledge. Brendan Buck, a spokesman for House Speaker John Boehner, R-Ohio, said the purpose of the new deficit-reduction committee would be to “cut spending as much as possible.”
Democrats whose opposition to cuts in benefits for seniors and people with disabilities was another roadblock to a bigger deal haven’t changed their tune, either. “Democrats are Democrats. They will not fix entitlements,” Norquist said. Indeed, House Democratic leader Nancy Pelosi was headed to Texas today to discuss what she called her party’s “commitment to Medicare, Medicaid and Social Security.”
Other are more hopeful that lawmakers will be able to compromise on policies aimed at spurring the economy. By agreeing on an economic stimulus plan, “we could show the world that actually it’s not complete dysfunction in Washington,” says Austan Goolsbee, former chairman of the White House Council of Economic Advisers.
‘Still plenty of things to worry about’
Wall Street professionals aren’t holding out hopes for eventual political reforms to alter short-term market jitters.
Joe Kinahan, chief derivatives strategist for brokerage TD Ameritrade, says the odds of a snapback rally aren’t high, given debt woes in Europe that increased last week over concerns in Italy.
“There are still plenty of things to worry about,” Kinahan says. The difference between this and past sell-offs “is that then many problems were due to internal forces,” he says. “We forget about what a global economy means, and it’s this.”
Shawn Limerick, a financial adviser for Boston-based Bay Financial Associates, says clients close to retirement are scrambling for advice.
“People are nervous, and they should be,” he says. “The wounds from the great recession in 2008-2009 haven’t even healed,” he says. “They are worried about the economy falling off the cliff again. They are worried about losing money.”
Limerick sees opportunities amid the uncertainty and advises against rushing to pull money from the market. “You should leave it there until we see where this leads,” he says. “This could be a pothole — well, a big pothole — on the road to recovery.”
In 2010, the S&P 500 sank 16% in a little more than two months. After bottoming in July, stocks surged to new bull market highs. That was preceded by 2008’s market swoon that ended in March 2009, but not before the S&P 500 had dropped nearly 57% from its previous high.
“When the financial markets collapsed in 2008, it seemed like the end of civilization as we knew it,” says Eleanor Blayney, a financial planner in McLean, Va. “But those who were able to stick through it actually came out very well.”
Opportunistic investors have long used big downturns such as last week’s as buying opportunities. But increasingly, many can no longer stomach the market’s wild swings.
“The market seems to be more volatile than it’s ever been. Any news seems to rattle it,” says Marilyn Rosenbaum, a 54-year-old pharmaceutical sales executive from Casper, Wyo.
She’s contemplating some moves in her 401(k) retirement account, but for now, standing pat. “We’ve already had this big drop, so it wouldn’t be to my advantage to pull it out,” Rosenbaum says.
“The headlines can get the better of you and turn what should be a strategy you had in place for the long-term into something that’s emotional,” says Judith Ward, a T. Rowe Price financial planner. Investors who need their savings soon shouldn’t invest in the stock market, she says. “But for long-term horizons, we try to tell people just to try and wait it out.”
Lazlo Birinyi of market research and money management firm Birinyi Associates, remains bullish, largely because corporate earnings have remained robust. “The average correction is about 13%, so while this doesn’t make (the sell-off) any less painful, it may not be the end of the world, but you can see it from here.”
Selling pressures could push prices lower, but Birinyi expects the S&P 500 to climb to as high as 1500 by mid-2012 — up to 25% from Friday’s 1199.38 close.
Birinyi suggests investors can make more money in individual stocks rather than market indexes or exchange-traded funds.
While the near-term outlook for the market remains murky, strategists such as Mark Heebner of Index Funds Advisors are convinced volatility will likely rule because of rapid-fire computerized trading which move huge blocks of shares and can cause wild market gyrations.
So expect more whipsaw trading sessions like Friday, when the Dow Jones industrial average recovered 170 points of Thursday’s 513 point loss, then sank more than 200 points before closing up 61 at 11,444. For the week, the Dow lost nearly 6%, the S&P 500 7% and Nasdaq, 8%.
How bad could it be today? “I think it will be a negative day. To say how much, I don’t know,” says Doug Cote, chief market strategist for ING Investment Management.
“What happens with the S&P downgrade, the net effect on the economy and globally, is a marked increase in risk,” he says. “It will mark down all risk assets, both (stocks) and fixed-income (securities), and reflect some duress until we get to the right levels.”
When will things sort out?
“It is too early to tell,” says James Stack, head of Whitefish, Mont.-based InvestTech Research. “If we’ve seen the market’s highs, it’s unlike any bear market in the past 30 years. I’m not looking for reasons to stay bullish, either. I wish the crystal ball was more clear. This week will be critical to the stability of the market.”
courtsey: USA TODAY