Downgrading U.S. Sovereign Debt Rating
On August 1st, Fitch Ratings downgraded long-term sovereign U.S. debt to AA+ from AAA., citing an “expected fiscal deterioration over the next three years”. They also projected a mild recession in Q4 2023 and Q1 2024, which is contrary to recent statements by Bank of America, JP Morgan, Morgan Stanley, and the Federal Reserve that do not believe the country will slide into recession. The four mentioned a “soft landing” will take place rather than a recession.
Goldman Sachs reported they do not believe there are meaningful holders of Treasury securities who will sell due to the downgrade by Fitch stating many investment mandates refer to holding Treasury securities rather than AAA rated bonds.
Warren Buffett doesn’t seem too concerned. He said “Berkshire bought $10 billion in U.S. Treasurys last Monday. We bought $10 billion in Treasurys this Monday. And the only question for next Monday is whether we will buy $10 billion in 3-month or 6-month” T-bills, Buffett told CNBC’s Becky Quick . “There are some things people shouldn’t worry about,” he said. “This is one.”
A downgrade from AAA to AA+ by S&P in 2011 had little impact on holders of Treasury securities. The news this past week, however, did send stocks lower. The Dow lost 1.1%, the S&P lost 2.3% and the NASDAQ negative 2.8% for the first week of August.
Fixed-Income YTD returns as of August 7th:
Government Bonds 1.18% 1.13% 1.18%
Corporate Bonds 2.28% 2.77% 4.37%
High Yield Bonds 6.06% 6.64% 5.91%
Short Intermed. Long
Bonds are struggling to regain their footing this year, attempting to recover from a disastrous 2022 when the Fed raised the federal funds rate seven times in their attempt to slow double digit inflation. Going back to March 2022, the Fed has now increased rates 11 times.
When interest rates go up, the value of bonds held by investors goes down, creating losses in existing bond portfolios. The good news is inflation has begun to slow down, while the economy and employment continues to expand, even after the Fed has raised rates by 5.25%.
Barron’s reports consumer prices were up 3% in the most recent 12 months ending in June, down more than 2/3rds from the four-decade inflation peak in 2022. Also, the futures markets are betting the Fed is done hiking rates and will leave its federal funds target at 5.25%-5.50% and may begin to lower rates in 2024.
Unfortunately, problems persist in bonds. The long bond yield has risen to 4.27% in early August, up from 3.84% in June, Barron’s reports. They also report the Treasury’s debt burden is now reaching $5.2 billion a day for the next 10 years as reported by the Congressional Budget Office. Higher interest rates on Treasury securities also add to the cost of funding the government. Despite the country running at full employment, Washington continues to go deeper in debt, one reason behind the Fitch downgrade.
July CPI Report
The long-awaited Consumer Price Index report for July was announced August 9th. CPI rose 3.2% from a year ago. The Bureau of Labor Statistics said 90% of the increase came from shelter costs, up 7.7% during that period. Prices rose 0.2% for the month, in line with the projections from Dow Jones. The annual rate was slightly below the forecast of 3.3%. Stock futures on August 10th, rose on the “good” news.
Banks Again in the Spotlight
Moody’s, a major rating agency, jolted the market the second week in August with their rating downgrades on several small and mid-size financial institutions. Moody’s cited “ongoing strain in the U.S. banking sector, including increased funding pressure and potential regulatory capital weakness”.
The recent bank failures of several months ago seemed to be behind the market. This downgrade came out of left field and took investors by surprise. Once again, stocks had a sharp negative reaction to the news. Moody’s also left open for review and possible downgrade of six large banks, including Bank of New York Mellon, State Street, and Northern Trust. In a rebuttal to Moody’s downgrade, JP Morgan Analyst, Steven Alexopoulos, stated, “those concerns are already priced into the stocks and the concerns are already well understood and regional bank stocks now have upside from current levels”.
Last year most stocks were down, but growth stocks lost significantly more than value stocks. This year has been a flip-flop back to growth.
The following chart, provided by Goldman Sachs, shows the outperformance of growth as of August 4th:
Value Core Growth
Large 6.78 17.74 29.41
Medium 7.53 10.58 15.53
Small 8.52 12.10 15.31
So far, the month of August is living up to its reputation as one of the worst months for stock investors. Since 1987, the month of August has been the worst month for the S&P 500 according to CNBC. Technology stocks are down 4.9% in August. Tech was due for a pullback after its incredible move upward this year. The week ending August 12th, saw Tesla fall by 4%, Nvidia drop by 8.6%, Apple continuing its slide, down 2.3%, Adobe down 3.5% and Meta (Facebook) down 3% according to Barron’s.
Dow stocks for the month are little changed. One big winner last week was Eli Lilly, up 78 points or 17.5%. The company’s new diabetes/weight loss drug, Mounjaro, is soon to become the largest selling drug in the world, with a cost of $1,000 per fill on GoodRX. Last week good news regarding weight loss and improved health benefits caused the stock to surge.
The RMR investment committee meets regularly to monitor events as they unfold and will take prudent steps, if necessary, in our models if and when it is deemed appropriate.