Fitch — a prominent ratings agency — downgraded the US’ long-term debt to AA+ from AAA last night.
It wasn’t a complete surprise. Fitch put US debt on watch in May, basically warning us about the downgrade.
But it’s conjuring up bad memories of August 2011, when Standard & Poor’s cut its own rating on US debt. S&P’s downgrade sparked a market panic. The S&P 500 dropped 6.7% in a day, while gold prices soared.
Don’t fret. Fitch’s downgrade may not cause as much pain this time around. The debt ceiling has been suspended until 2025, so there’s less concern about the Treasury repaying its debt.
But you shouldn’t ignore this news, either.
Fitch’s news highlights the importance of Congress’ upcoming budget deadline in October. While there’s arguably less at stake than with the debt ceiling drama this summer, a government shutdown is possible.
Stocks also look especially vulnerable heading into a seasonally rough two-month period. The impact of any negative news could be amplified in low-volume markets. We haven’t seen a 1% down day in the S&P 500 this summer, either. This is unusual — the S&P 500 hasn’t gone a whole summer (June-August) without a 1% drop since 1979.
Make no mistake: this may not change the perception of stability in US debt. The dollar is still seen as the dominant global currency — even with ratings downgrades — because the network effects are so powerful. And despite all the challenges we face, the US economy is on solid footing compared to most economies.
So what does this mean for me?
Stay cautious. Rates are still high, even though the Federal Reserve is slowing the pace of rate hikes.
Look for quality. This environment could favor traditionally defensive stocks with economically resistant business lines, and larger, quality companies that can withstand high-rate pressures.
Respect the bull market. Bull markets are tough to fight, and the S&P 500 is up more than 20% since the October lows. If you’re nervous about the Fitch downgrade, remember that portfolio positioning isn’t black and white — or buy and sell. If you’re worried about the future, options prices are historically cheap, and short-term instruments could help you ride out this storm.
*Data sourced through Bloomberg. Can be made available upon request.