As discussed in last week’s article entitled Kicking the Can Down the Road, for the 73rd time since the early 1970s, U.S. politicians reached an agreement on terms surrounding an increase to their debt limit.
When put that way it doesn’t seem like a big deal. In fact it sounds almost like a technicality. We knew that even if at the 11th hour something would give and a deal would get done. So why worry about it? Business as usual, right?
Well, not really. There was an important difference this time. This time around the credit rating agency Standard & Poor was watching closely, and was ready to act if they didn’t like what they saw.
Suffice to say they were less than impressed with U.S. plans to reduce their deficit, so they took action. Late Friday afternoon (after the markets had closed), for the first time in history, U.S. government debt was downgraded from AAA to AA+.
If you have been following the news you are likely painfully aware that the market reaction has been extreme, with stock markets around the world down sharply on the week.
Does it make sense?
Well, yes and no.
Yes, the downgrade is a serious issue and could have an economic impact depending on how things pan out. Combined with other factors there is a less than trivial possibility the U.S. could slip back into recession, which of course would not be good for the stock market.
But on the other hand, here is what some might find confusing — that investors would react to a downgrade of U.S. treasuries by dumping their stocks and buying the very thing that was downgraded — U.S. treasuries. So while intuitively one might expect this downgrade to lead to a weaker U.S. dollar, and potentially higher U.S. interest rates, the very opposite happened.
Interest rates fell, and the U.S. dollar went up — against most currencies, with the notable exception of gold. Forgive me for jumping the gun by referring to gold as a currency, but in my opinion (for all intents and purposes), that is what gold has become.
So what is an investor to do?
To begin with, don’t panic. At times like this, strange things can happen — things that don’t always make fundamental sense. Then typically it is only when things settle down that markets tend to normalize. It is quite possible that there is nothing wrong with your portfolio — even if it has fallen in value. Initially at least, your best course of action may be to do nothing.
But at the same time, it is becoming increasingly apparent that the world has some fundamental problems to work through — problems that won’t be solved overnight.
This doesn’t mean that you should sell everything and put your money in the bank. Going forward paper money (cash) may turn out to be one of your worst investments. But you should at the very least have a good look at your current portfolio and assess whether it is appropriate.
Now would be a good time to begin this process. Please don’t hesitate to call if you need assistance.
Jim Grant, CFP (Certified Financial Planner) is a Financial Advisor with Raymond James Ltd (RJL). This article is for information only Raymond James Ltd, member Canadian Investor Protection Fund.
For more information feel free to call Jim at (250) 594-1100, or email at jim.grant@raymondjames.ca. and/or visit www.jimgrant.ca