America’s loss of its Standard & Poor’s AAA debt rating on Friday will continue to provoke strong reactions, from markets and pundits alike. But nothing has really changed. The downgrade just confirmed what everyone already knew: Despite last week’s debt ceiling deal, the U.S. federal budget is still a mess. As a result, my outlook, and the advice I’d give to individual investors, remains more or less what it was before S&Ps “historic” decision.
Here are the essential points:
- Sizable further budget cuts will have to be made. And one thing that almost all economists agree on is that reducing a deficit – whether by cutting the budget or raising taxes – removes stimulus from the economy. That makes a slowdown more likely in the short run, whatever the long-term benefits.
- Stocks are likely to decline further. The Dow’s 10% drop over the past two weeks reflects growing expectations of another economic slowdown. But stock market history suggests that share prices could fall for several more months before they hit bottom.
- The extent of any market decline will be decided in Europe. The scariest scenario is a default by one of the countries that uses the Euro. That could cause huge losses at banks around the world and trigger a second financial crisis. If the global banking system escapes that danger, on the other hand, then the U.S. economy may falter but the second half of a double dip would likely be shallower than the 2008-09 recession.
- Forget about trying to get out of the market and jumping back in when stocks hit bottom. Short-term trading is a losing strategy for small investors. What you should be focusing on is your long-term investment position. Certainly, it makes sense to sell things you’ve been meaning to get rid of for fundamental reasons and accumulate cash – but with the goal of repositioning, not market timing.
- Conserve your cash and look for financially strong stocks at depressed prices. If there is any bright spot in today’s outlook it is that buying cheap always enhances long-term returns. What’s more, the declining creditworthiness of U.S. Treasury bonds suggests that in the future there will be a shortage of AAA investments, especially those that pay attractive yields. My inclination, therefore, would be to keep an eye on stocks with huge cash hoards, minimal debt or AAA credit ratings, such as the shares I discussed in last week’s column.