When Standard & Poor's says it might lower its top AAA rating on U.S. government debt, the stock market fell sharply. Traders were worried that if a downgrade happened, it would send interest rates higher. And, in turn, raise companies' borrowing costs.
But short-term investors were driving the markets Monday. For individual investors who are in the market for the long haul, a downgrade might not be as devastating as it seemed at first — especially if their biggest investment is in the stock market.
The downside of a lower U.S. credit rating would be another drop in Treasury prices. And they've already been falling because interest rates are expected to rise as the economy grows. But some analysts say that stock prices would rise over the long term because they'll have better returns than bonds and cash.
"For people who bought bond funds and think they won't lose money — you're wrong," says Linda Williams, director of fixed income investments for Minneapolis-based private wealth management firm Lowry Hill. "When rates rise, those bond funds will be worth less than what you paid for them."
Stocks, meanwhile, will look more appealing compared to other investments that are losing value.
"The equity market may be the best alternative, and it could improve," says Randy Bateman, chief investment officer of Huntington Funds. He noted that U.S. businesses have strong balance sheets with record amounts of cash — unlike the indebted federal government.
A U.S. downgrade would also likely hurt the dollar's value. That would help stock prices of U.S. exporters, because their products would be cheaper for customers buying in foreign currencies, says Philip Tasho, chief investment officer of TAMRO Capital.
"The federal government's financial position is terrible," Tasho says. "Corporate America's is the best in a generation."
S&P's warning called attention to the fact that investors owning the 10-year Treasury note, or Treasurys with longer maturities, are particularly vulnerable.
"They have to realize that their bond portfolio is not where they want to be taking risk. You need to have a short maturity to protect yourself against a rising interest-rate scenario," says Tom Atteberry, co-manager of the FPA New Income Fund.
Investors shouldn't overreact based on Monday's news, however, cautioned Bill Stone, chief investment strategist for PNC Wealth Management. It shouldn't come as a surprise to anyone because the government has been taking on billions of dollars in debt since the financial crisis.
"If you had all your money in U.S. Treasurys, I'd say there might be some other places that are more attractive," he says, citing corporate debt and stocks. "But I don't think there's a reason to panic."
The risk that the U.S. government will default on its debt any time soon remains "infinitesimally remote," he says.
Some past downgrades — and threats of them — have had little impact on a country's stock market.
On May 21, 2009, S&P says it was considering a downgrade of Britain's AAA rating. The country's FTSE 100 index sank 5 percent over the next month and a half, but investors quickly shrugged it off. It rose 24.6 percent between May 21 and the end of 2009.
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