U.S. Debt Downgrade

As most of you know, Standard and Poor’s (S&P) downgraded the United States credit rating from AAA to AA+ late on Friday.  While the downgrade was not a big surprise, there certainly may be an emotional reaction to it in the coming days and weeks. The resolution to the debt ceiling debate in Congress (see Forefield article), was not enough to convince the rating agency of the country’s future economic status. The people at S&P apparently aren’t the only ones who are not convinced that Congress will effectively address these issues - a recent CNN poll showed the disapproval rating for Congress at an all time high of 84%.  The pressure will be greater than ever for them to reach a responsible solution to our country’s debt problems.

Fear and greed tend to drive the stock market in the short term and we have seen significant volatility in the past few weeks.  We made it through a very deep recession in 2008 and 2009 with the help of some historic steps taken by the U.S. government to get the economy on the path to recovery.  Unfortunately many of the tools they used are no longer available to them. Corporate earnings have been strong and from that perspective it looks like we are coming out of the recession. Most economists are predicting growth of around 3% for the remainder of the year.  Unfortunately consumer confidence continues to slide and the consumer makes up over 70% of our GDP.

We think it is important to not just focus on the stock market at times like this. Most of you have an allocation to cash, bonds, and other assets in your portfolio. As we regularly discuss, this allocation, along with having sufficient cash reserves, is critical to the amount of risk in your portfolio.  One result of the downgrade may ultimately be higher interest rates, which may be good for investors in the long run (although it could cause some pain to bond investors in the short term). However, rising rates will hurt those who have mortgages, credit card debt or other loans. The impact of a rise in rates will depend on your own personal situation.

We are surely in for a period of volatility on both the investment and government policy fronts. The impact on future tax rates and government benefit programs such as social security will be important. While we don’t know what the full impact of the downgrade will be in the short term, we do know that it is not usually a good idea to make changes to your portfolio in times of extreme emotion and stress.  A 10% drop in the equity markets like we have seen over the past few weeks can actually lead to some planning opportunities.  If you are still accumulating assets and dollar cost averaging into the markets, these lower values can be very attractive.  There are also gifting and Roth conversion opportunities to consider and we will explore some of these in more detail in the coming weeks.  

We wanted to communicate some of our thoughts as we know you are trying to understand what it might mean in your own personal situation. We will continue to monitor the situation to help you address these issues.  As always, please feel free to contact us if you have any questions or concerns.

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