EmailIf uncertainty is the enemy of the equity market, then it can be said the equity market has a lot of enemies right now.
Standard & Poor's made the enemy list over the weekend after downgrading the long-term U.S. debt rating from AAA to AA+. That move should not be seen as a major surprise since S&P had been hinting for weeks that the U.S. needed to agree to long-term deficit cuts on the order of $4 tln. That didn't happen and so S&P did what it did.
Of course, it didn't help matters that S&P's own budget math was off in its assessment of the fiscal situation in the U.S. That fact drew immediate criticism from government officials, yet S&P stood its ground and even said the risk of further downgrade remains due in part to a lack of confidence in the political dynamics in Washington.
For good measure, China called out the U.S. for its profligate spending, saying it has a "debt addiction" and that the "good old days" of borrowing are over. Outside of the Federal Reserve, China is the largest holder of U.S. Treasuries.
In the midst of the S&P brouhaha, European officials were conducting emergency meetings to discuss how to stem the contagion effect of peripheral country debt problems. The latest solution has the ECB buying Italian and Spanish bonds as a stop-gap measure until the European Financial Stability Facility has the proper political and financial backing to take on that task.
The ECB decision helped reverse the tide of selling interest in the aforementioned bond markets, but it is an altogether different situation for global equity markets. Most have fallen at least 2.0% today as the wave of uncertainty about the economic outlook has prompted a liquidation trade and a flight to safety that is landing in gold and, yes, the U.S. Treasury market.
Gold prices are currently up 3.0% at $1701 per troy ounce while the 10-year Note is up 18 ticks, lowering its yield to 2.50%. The move in the Treasury market underscores the idea that it is its own safety trade because of its size and that, downgrade or no downgrade, there is the realization that U.S. debt is still money good.
The S&P 500 for its part is indicated to start the day down about 2.5% as risk assets are losing out in the early going.
The specific cause for the bearish bias can be, and will be, debated all day.
For us, the ultimate driver is uncertainty.
Say what one will about the S&P downgrade, the emergency meetings in Europe, the finger-pointing in Washington, and the rebuke from China that was punctuated with calling for the option of establishing a new global reserve currency -- it all adds up to more uncertainty.
Accordingly, the risk premium on stocks is set to rise even further. Should the cash market start the day down 2.5% as expected, the earnings yield on the S&P 500, based on forward four-quarter earnings, would be roughly 9.0%. That is 650 basis points higher than the current yield on the 10-year Note and where things stood around the March 2009 low.
--Patrick J. O'Hare, Briefing.com
Patrick J. O'Hare is the Chief Market Analyst for Briefing Research, Briefing.com's institutional research service. To request a free trial please email researchsales@briefing.com.
