Sunday 24 February 2013

AAA donwgrade will bring the Rally to a halt

The loss yesterday of the UK’s AAA rating, in this instance a downgrade by Moody’s to Aa1, will have some very predictable effects. Firstly, both the other main agencies are likely to follow suit as the UK is presently on negative watch and its public finances are deteriorating. This means there is more short-term bad event news to come in the next couple of weeks.

The graph below shows the sovereign debt reactions of other countries that have suffered the ignominy of a downgrade and so anyone who thinks the UK is going to keep record low gilt yields is in cloud cuckoo land. As real rates rise this will have a negative impact on the Governments plans – it may perhaps result in more QE, but the long-term trend is set for a reversal in low bond yields. The overall macro impact will not be good.

Even the politics is bad - if the downgrade further reduces the chance of a Tory re-election and instead a return of the crazed Ed Balls, then the markets will be even more sombre…

However, there is an even better reason to sell the FTSE and that is because it is nearly March. In each of the last three years, human optimism has kicked in for a Santa Rally and then a mad January and February as everyone wants to believe that this time it is different – this year will be the year that the effects of the financial crisis start to leave us blah blah… And of course, each year disappoints as the debt overhang is simply monstrous.

The script usually goes - Q1 GDP numbers start to disappoint, we realise that the Euro area is still in trouble and the UK is still not having any meaningful impact on reducing its debts despite the austerity programme.

Then. by the mid-year as the usual suspects line up, the summer months of low volume provide the stabilisation period before we build up to a Santa rally again.
Given the historic economic reality that it takes 7 years to recover from a financial crisis, together with overbought markets and modestly stretched valuations, the chances of a March correction were high anyway – with the UK debt downgrade, it is, in my opinion, now baked in.

Tin Hats all round.

This post is sponsored by spreadbetmagazine.com

8 comments:

Mark Wadsworth said...

well if this means that interest rates are going to go up, then yippee and trebles all round is what I say.

Anonymous said...

are "just in time" share ISA purchases enough to also up the FTSE, or are the volumes too small to be significant?

CityUnslicker said...

Anon - volumes for ISA's too small to be meaningful really, it's about £10 billion a year, so even a couple of billion in a week is going to have only a small impact, if any.

MW - there is a big disconnect between real rates and what the bank pretends they are!

Graeme said...

maybe Os and Cam will start reducing the level of state spending as a result?...not holding out much hope

andrew said...

Nowadays the ftse 100 is signifacntly made up of companies that have most of their earnings outside the UK - in foreign currency.
One likely impact is that sterling falls.
This means the USD (for the sake of argument) based value rises in terms of GBP.
This means upward pressure on share prices.

Of course, given that we started the year at 6000, we should really be ending it at about 6300 so there is likely to be some mean reversion - but to put a causal link on this may be going a bit far.

Timbo614 said...

Not a stumble this morning... I think the Market looks towards Canada and sees the QE refuelling station on the horizon and is running full pelt towards it!

Budgie said...

CU, I don't think you are looking at this properly. The government's policy is to reduce the value of the pound, and create steady 5% inflation. The reasons are to kick start both exports and import substitution, whilst stealth taxing us and reducing borrower's debts (including the government's).

They are doing a grand job (this is sarcasm btw, because I don't agree that their policies are correct). But the net result is that the "peound" (h/t to Grocer Heath and Wislon), is going to be worth so very much less in your pocket.

Hence almost any major asset is better than the pound. But I think the state of the economy will hold down house prices. And I definitely would get out of Gilts. So gold and shares are the best bet in a miserable future. Euro here we come!

Agence communication said...

"" The loss yesterday of the UK’s AAA rating, in this instance a downgrade by Moody’s to Aa1, will have some very predictable effects. Firstly, both the other main agencies are likely to follow suit as the UK is presently on negative watch and its public finances are deteriorating. This means there is more short-term bad event news to come in the next couple of weeks.
""