Global Markets made a significant recovery between March 2009 and Dec 2010. But it was perceived as a big short covering bounce. There was real concern back then about how sustainable the Global economic recovery can be.
Major economic concerns back then:
- US Govt Debt and what QE would do to the size of the Debt.
- Gold was the preferred choice for Investment back then.
US Politics took an interesting turn in Nov 2010 when President Obama party lost badly in midterm polls and Conservative Tea Party movement in Republicans got a big boost. Their main agenda: Cut down Govt debt. This became the big political story with Debt Ceiling issue as Make or Break item
Debt Ceiling 101
It is an upper limit set on the amount of money that a US government may borrow. It's like a Credit limit on your Credit Card. Now, it's funny that Congress authorizes expenditure separately and then Govt pays for it from its revenues and borrowing. And then comes a time, when Govt reaches the debt limit and it's revenues are not sufficient to run the Govt. The only option left: more borrowing but since Congress has capped it, there is fear of default on payment obligations. US Treasury then needs Congress authorization and President approval to borrow more so that it can pay for US Govt expenditure and fulfill payment obligations even on existing US debt. It's a serious economic issue which becomes big political issue.
What happened in August 2011?
Republicans in Congress demanded major deficit reduction as part of raising the debt ceiling. Obama was on defensive and both sides reached an agreement on August 02 2011. But the way whole exercise went and kind of weak arrangement both parties reached: S&P credit rating agency downgraded US debt rating from AAA to AA+. It was a shock for debt market
Here's how S&P500 index reacted
It's quite interesting how S&P500 reacted to Credit downgrade news. It did not sell off majorly on the news and formed a bottom which it maintained over next two months. Actually, market had already discounted that news prior to the announcement (see S&P500 selling prior to the debt ceiling agreement). What's more interesting: US market remained volatile for next 2 months but it never formed a fresh low. The market always gives a strong signal on what it intends to do.
Was Market wrong in dismissing Credit ratings downgrade?
The answer is No. The Market was pricing in the recovery and improving situation while credit rating agencies and economists were looking at the real view mirror. Just see how US deficit started coming down dramatically from 2013 onwards
The most fascinating achievement of Obama: How Fed Deficit has come down pic.twitter.com/B59Kp80Isc
— Deepak Singh (@smarket) August 20, 2015
No wonder US Market remained on recovery and Bullish path
Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.
2011 August Credit rating downgrade was the Ultimate Pessimism moment. Hence next time you see a hugely negative news flow - Focus on what market is doing and not drown yourself in pessimism
Disclaimer – The state of the market notes is Deepak’s perspective on the market. The column is purely for educational purpose. Nothing contained herein is a solicitation to trade or a recommendation of a specific trade. By reading this publication you agree to make no trade relying in whole or in part on the comments of the writers