August 2023 Market Update
The big news recently, aside from the imminent return of college football, is that Fitch, a bond rating agency, has downgraded its rating of US government bonds from AAA to AA+. This downgrade by Fitch is the second time in US history that a major rating agency downgraded US debt (S&P did it in 2011). As of now, Moody’s is the only remaining major agency with an AAA rating on US debt. If Moody’s were to also downgrade our debt, the US would not widely be viewed as an AAA-rated country. Potentially, this could mean that investors would demand more interest for holding a “riskier” asset, driving prices down and yields up, as well as increasing the cost of borrowing for the government. Further, if the US were to receive more downgrades, that could pose more concerns, although that doesn’t seem likely anytime soon.
If our debt rating were downgraded, I’m not sure that this would cause bond investors to go elsewhere. The US is still perceived to be a good credit risk, and I’m not sure what other countries would be perceived as a better risk. The US bond market is easily the largest in the world, and for foreign governments or asset managers looking to place billions of investments into bonds, there really is no alternative, yet, to our market.
It’s also important to remember that the largest holder of US government bonds is-you guessed it-the US itself. According to research done by the Peter G Peterson Foundation, roughly 70% of US public debt is held by domestic investors, and the largest of those is the Federal Reserve System. Domestic mutual funds represent the second largest group of holders, followed by banks, state and local governments, pension funds, and insurance companies. China and Japan are the 2 largest foreign holders of US debt, and combined they own just 8%. The remaining US debt (the 30% that is not public) is owned by Government agencies, with Social Security easily being the largest single holder.
My point is that I don’t think it’s likely that the Federal Reserve, or state governments, or Social Security will sell off their US bond holdings regardless of rating agency actions. What this is, is a wake-up call: US fiscal policy is on an unsustainable path. That’s not my opinion, it’s Fitch’s and Standard and Poors’s. While this does not change my short-term views on the markets, the financial health of our nation is something that should concern us all. Compared to other countries, the debt situation in the US is projected to keep worsening. And given the lack of commitment by Congress and other policymakers, there seems to be little appetite to improve these conditions. After all, what Congressperson wants to stop giving free money and pork projects his or her district? I’m positive it’s not easy to pick where to cut spending, and I don’t blame them for fighting for the money…that’s the way the system is set up. Maybe the system needs an overhaul.
As I wrote, the downgrade from Fitch is does not impact my immediate outlook for investments. When our debt was downgraded in 2011, the S&P 500 fell 8% in the immediate aftermath of the downgrade, yet it was UP 16% in the 12 months following. Moreover, demand for the newly-downgraded bonds increased, pushing the 10-year Treasury yield down nearly a percent in the next year. So, it was a good time to be invested.
Rather, this is a reminder for investors to not get complacent, which can easily happen in a bull market. To that point, stock ownership in the US is on the rise: 61% of people reported owning stocks in the latest Gallup poll, the highest % since 2008. If you don’t remember what happened to stocks in 2008 and early 2009, suffice it to say that it wasn’t good.
In my opinion, there are very high valuations being paid for stocks of companies that don’t have great earnings outlooks. I think that blindly placing money into stock funds, or worse yet, chasing high-fliers, is a recipe for poor investment performance. Most of us don’t need to earn 10 or 12% on our money to realize our financial goals. In fact, many of the financial plans that we prepare only require 5 or 6% returns. I’m not suggesting that a person shouldn’t invest in stocks; I believe it is a great way to build and maintain wealth. If you need to catch up on your goals or are young and have a 50-year time horizon, then you can likely afford to be aggressive. But taking more risk than is necessary is, well, risky!
The stock market and our offices will be closed on September 4 for Labor Day, and September 15 is when quarterly estimated tax payments are due, if that applies to you. Otherwise, enjoy the rest of the summer, and please don’t hesitate to give us a call if we can be of assistance.
As always, these opinions are mine, and may or may not be the same as those of Raymond James. This is not a solicitation to invest, although we do invite you to review your portfolio with us to see if any changes should be made. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk including the possible loss of capital. Asset allocation and diversification do not guarantee a profit nor protect against loss. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Individuals cannot invest directly in any index. U.S. government bonds and Treasury notes are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury notes are certificates reflecting intermediate-term (2 – 10 years) obligations of the U.S. government. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Scott Mitchell and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional.
