S&P Downgrade May Boost U.S. Bonds, Hurt Stocks

Monday, 08 Aug 2011 08:59 AM

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The decision by Standard and Poor's to strip the U.S. of its AAA ratings will send stock prices falling in the coming days but overall, bonds will perform well and serve as a safe haven for investors, analysts say.

Standard and Poor's based its decision to knock U.S. ratings down a notch to AA+ on a belief that recent measures aimed at narrowing U.S. deficits in exchange for lifting the government's $14.3 trillion debt ceiling fell short of what was needed to nurse the economy to greater fiscal health.

Invest in safe bonds, experts say, since many fixed-income investors have already priced in the possibility of such a move by ratings agencies.

Borrowing costs won't skyrocket on the downgrade, either, experts say.

"It is all very reminiscent of what happened in Japan. We have had a huge and colossal amount of debt and getting rid of it is very difficult. The pressure for spending cuts will grow and grow and then it is very difficult to generate meaningful demand. That is bearish for risk assets, but bonds will surprise people with how well they do," says Nick Gartside, international chief investment officer for JP Morgan Asset Management, according to the Financial Times.

Others tell the Financial Times they agree.

"A decade after Japan lost its triple-A rating, 10-year Japanese government bond yields are still only 1 per cent and the yen is as strong as ever," says Paul Dales, senior U.S. economist at Capital Economics.

Equity investors should be a little more nervous.

 "I would expect peak to trough to be more than 20 percent," says Graham Secker, an equity strategist at Morgan Stanley, the newspaper adds.

"In technical terms – indices would move from being in 'correction' territory to being 'bear markets.'"

Former Fed Chairman Alan Greenspan says stock markets will feel the heat from the downgrade.

However, while Standard and Poor's is grabbing headlines today, keep an eye on Europe, where a financial crises threatens to spread to Italy, a large economy whose demise could rock the global economy.

"We were doing fine until Italy ran into trouble," Greenspan tells NBC's "Meet the Press."

“That destabilized the European system, and the crisis re-emerged. Europe is very critical to the United States.”

European nations can draw from a $625 billion emergency fund, although doubts remain whether that's enough for a country of Italy's size.

Italian Prime Minister Silvio Berlusconi has said his government will balance the budget by 2013, a year ahead of schedule, in an effort to keep the economy from tanking.

Markets, however, want details.

"The decision to bring forward the balancing of the budget is a positive step but we need a lot more detail," says Raj Badiani of IHS Global Insight, warning that the promised reforms are unlikely to happen overnight, Reuters reports.

"The problem is Italy doesn't have time right now and the reforms they announced are easier said than done."

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