Credit Downgrade: What to Expect This Week

"People do not get what they want or what they expect from the markets; they get what they deserve. ... Mr. Market doesn't give a hoot. He's got a 'Capitalism at Work' T-shirt on and a sledgehammer in his hand."
--
Bill Bonner

Now that America's credit rating has been downgraded, how is Mr. Market going to respond when the markets open Monday morning?

No one knows. It could be nothing, or it could be ugly. Maybe this is a wake-up call; maybe the damage is already priced in. The Wall Street Journal recently asked dozens of investors, bankers, and economists what the downgrade means. Nearly all gave some variation of I don't know. S&P appears to have accomplished what perpetual underperformance never could: It humbled Wall Street.

Although the future is unpredictable, the past is starting to make more sense. From my perspective, it seems that Thursday's 512-point selloff could have been triggered by early knowledge of the downgrade. There's no way to prove this, but think about it: There was no big news on Thursday. No banks failed. No hedge funds collapsed. No countries defaulted. If anything, Thursday brought a spate of earnings reports that should push corporate profits to an all-time high this quarter. Further, rumors of an impending downgrade were spreading like wildfire on Twitter by early Friday morning, more than eight hours before the news was made public. This all potentially bodes well for the markets going forward. Last week's bloodbath may have priced in the bad news.

Then again, it can't be stressed enough that the traders and algorithms controlling daily market movements have little in common with the long-term, business-oriented view of most Motley Fool investors. After the Flash Crash last May, New Yorker columnist James Surowiecki made a great point: "I don't think yesterday's crash is evidence the market is irrational. It's more that it's a-rational: The computers aren't panicking or herding. They're just following simple rules."

Those rules have nothing to do with the intrinsic value of businesses. They're more about a game of preempting one another -- computers trying to buy and sell before other computers buy and sell. If it comes, a selloff this week isn't necessarily indicative of panic and gloom. It could simply be the actions of short-term investors who are trying to get out first as they perceive that others will be panicky and gloomy. This is why it's so important to ignore short-term market moves and focus on business values.

The real threat from the downgrade is a potential rise in interest rates, which could slow the economy and swell budget deficits. But as I wrote last week, this is no sure thing. Japan's interest rates fell after it lost its AAA credit rating. JPMorgan Chase once did a study showing the effect on interest rates after a group of countries were stripped of their AAA rating. One week out, rates had hardly budged. On average, countries with AA credit pay more to borrow than those with AAA ratings do, but the difference is typically already reflected before a downgrade hits. This tendency bodes well for Treasuries, and it hits on a point that economists have been making lately: The Treasury market is so big, and there are so few alternatives, that the downgrade might just mean that AA becomes the new AAA.

And keep in mind that the downgrade should have surprised no one. S&P put the Treasury on negative-credit watch back in April, stating that there was a 50-50 chance the United States would lose its AAA rating in the near future. S&P's rationale for Friday's downgrade wasn't based on proprietary financial analysis but rather on a statement of the painfully obvious: America's political system is dysfunctional. Who didn't already know this?

Something else to be mindful of is who this downgrade came from: a rating agency with a dubious track record at best. If Goldman Sachs had downgraded Treasuries, no one would care. If Warren Buffett downgraded Treasuries, few would notice. Bill Gross, one of the world's most successful bond investors, ditched Treasuries earlier this year, and no one blinked. Asked about the consequences of the downgrade on Saturday, Buffett quipped: "Remember, this is the same group that downgraded Berkshire."

Indeed, the original downgrade report presented to the Treasury on Friday morning had a $2 trillion mathematical error. S&P doesn't dispute the mistake. After the Treasury pointed out the error, "S&P still chose to proceed ... by simply changing their principal rationale for their credit rating decision from an economic one to a political one," the Treasury wrote yesterday.

It's hard to argue that the United States doesn't deserve a downgrade -- particularly based on a dysfunctional legislature -- but keep it in appropriate context before making any personal investment decisions.

What do you think the downgrade means for your investments? Let us know in the comments section below.

At the time this article was published Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Follow him on Twitter, where he goes by @TMFHousel. The Motley Fool owns shares of JPMorgan Chase and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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68 Comments

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jokesl3

The DOW was down 300 points until Obama gave his little speach at 2:00, then the loss immediately doubled. Can't someone put a leash and muzzle on that stupid MF?

August 08 2011 at 4:04 PM Report abuse rate up rate down Reply
THE SHANKERS

Our country might still be one of the richest countries in the world, but judging from the way our politics play in our lives, we are certainly not one of the advanced countries of the world anymore.

August 08 2011 at 10:27 AM Report abuse rate up rate down Reply
John T's Voodoo

To all who put Obama in office I hope you like change. He will destroy our country and Tim just needs to get another job. He is a failure at the one he has.

August 08 2011 at 9:48 AM Report abuse +3 rate up rate down Reply
mily469

yes the tea folk have identified a problem. that is where it ends. tea folk cannot grasp the larger complex issues intertwined nor the subtle nuances needed to safely get us through this problem. they are not wired to solve deep problems. that is ok. but they also lack the ability to rrealize they are in over their heads. facts are not mean.

August 08 2011 at 9:43 AM Report abuse -2 rate up rate down Reply
hpemailme

As more sober minds consider ways to keep the Middle East from falling into the hands of the Muslim Brotherhood, Barack Obama is “fighting terrorism” by reaching out to the leader of one of the Brotherhood’s American creations. In the process, a White House official revealed that radical Muslims frequently advise the White House office headed by the president’s top adviser and alter ego, Valerie Jarrett. Preemptive Groveling
Flush with instances of American Muslims supporting Islamic jihad, Rep. Peter King is set to launch his investigation into the radicalization of U.S. mosques, imams, and the faithful they serve later this week. Barack Obama, ever keen to reach out to the Muslim community, decided to get ahead of this by sending a deputy to plead with the extremists for cooperation. On Sunday, Deputy National Security Advisor Denis McDonough spoke to a Sterling, Virginia, mosque some believe is a model of moderate Islam: the All Dulles Area Muslim Society (ADAMS), led by imam Mohamed Magid. Indeed, McDonough began by thanking Magid by name.
Although the Sudanese-born imam presents himself as an ecumenical, anti-terrorism leader active in “interfaith” outreach, his current associations — and those of others at his mosque — present a different picture....
======================================================================================
JOBS - JOBS - JOBS--------NOT COMING-JUST A DIVERSION

August 08 2011 at 9:40 AM Report abuse +1 rate up rate down Reply
daltonustynik

Thanks for tanking the economy you tea party ********. Becasue of your ignorance whats left of my IRA is in teh toilet.

August 08 2011 at 9:35 AM Report abuse -2 rate up rate down Reply
1 reply to daltonustynik's comment
hpemailme

NO - BECAUSE OF THE IGNORANCE OF PEOPLE LIKE YOU ---------S/P WANTED 4 TRILLION IN CUTS - THE TEA PARTY BUDGET- --------NOT THE OBAMA SPENDING PLAN-------------BTW - WHERE WAS THE PRES/DEM BUDGET FOR OVER 2 YEARS - OR LAST OCT?

August 08 2011 at 9:42 AM Report abuse +1 rate up rate down Reply
sjoberdix

Wall street and thier bought politicians have one act left, which was their end goal in the first place The retirement funds and the GM stock the government sold. Crush, its thier form of embezzlement. The retirement funds are the only place that has any money, they're going to steal every red cent.

August 08 2011 at 9:32 AM Report abuse +2 rate up rate down Reply
ificanrunlookout

We need a fresh crop of politicians running this country. Remember this come election time. Vote out all incumbents. And insist all our elected officials listen to the voters. Terms should be limited, the should contribute to SS just as we do and no more outrageous benifits. The need to learn within their means as the hard working middleclass does.

August 08 2011 at 9:31 AM Report abuse +2 rate up rate down Reply
blair188

This is the worst President in U.S history...I believe this has all been a calulated effort in breaking down our country in order to rebuild it the Soros way. God Help us. In the meantime..we must prepare for our families. There are times in our lives where being proven right is not a good thing and this will be one of them for me. I have been warning people for years to read the writing on the wall.. Well Obama..you ought to be proud of yourself..you managed to get Americans to walk with blinders on ...

August 08 2011 at 9:27 AM Report abuse +1 rate up rate down Reply
1 reply to blair188's comment
hpemailme

YES- OTHER COUNTRIES WARNED US- SOROS WAS CHARGED WITH ECONOMIC TERRORISM- WE WERE WARNED - ---Soros Event Sets in Motion New Attacks on Dollar---------------http://www.mrc.org/bmi/commentary/2011/Soros_Event_Sets_in_Motion_New_Attacks_on_Dollar.html

August 08 2011 at 9:32 AM Report abuse rate up rate down Reply
2 replies to hpemailme's comment
bushsnitemare2

TALK ABOUT BEING PARANOID.

August 08 2011 at 9:33 AM Report abuse -1 rate up rate down
hpemailme

BUSH- SEEMS YOU ARE A LITTLE STUCK IN BUSH ADM. -----IT IS OBAMA ADM. - HIS FAULT - AND SEEMS FACTS BOTHER YOU - PLEASE STOP YOUR PROPAGANDA -YOU POST B.S. INSTEAD OF FACTS ON BUDGET - YOU POST SLANDER INSTEAD OF ANYTHING WORTH A CRAP TO AMERICA - AND YOU GET PAID BY SOROS FOR THIS?- AMERICA IS NOT A DUMB AS YOU THINK - AND THAT BOTHERS YOU

August 08 2011 at 9:44 AM Report abuse +2 rate up rate down
bushsnitemare2

CHRIS WALLACE CALLED MICHELE BACHMANN A FLAKE.................NOW THATS PRICELESS!!!!!!

August 08 2011 at 9:25 AM Report abuse rate up rate down Reply