U.S. stock futures declined, following the biggest weekly drop in the Standard & Poor’s 500 Index since 2008, amid concern that a downgrade of the nation’s credit rating by S&P may worsen an economic slowdown.
S&P 500 futures expiring in September fell 1.7 percent to 1,177.50 at 9:21 a.m. in Tokyo. Dow Jones Industrial Average futures slid 190 points, or 1.7 percent, to 11,212. Futures pared losses after Group of Seven nations said they will take every action necessary to stabilize financial markets.
The U.S. credit rating downgrade threatens to extend a rout in U.S. stocks that wiped out $1.94 trillion in market value and erased the S&P 500’s gain for the year. S&P lowered the U.S. long-term rating one level to AA+ after markets closed on Aug. 5 while keeping the outlook at “negative” as the New York-based ratings company becomes less confident Congress will end Bush- era tax cuts or tackle entitlements.
“We’re in the midst of a sharp correction,” Matthew Kaufler, a portfolio manager at Federated Clover Investment Advisors in Rochester, New York, which oversees $3 billion, said in a telephone interview. The downgrade is “a monumental event. It creates greater uncertainty near-term. It was already a very fragile market. Over the near-term, there will be pressures as institutions and individual investors try to recalibrate what this means. It has a negative psychological effect. I’m not surprised.”
Economic Slowdown
Stocks have slumped for two straight weeks as manufacturing and consumer spending data showed the world’s largest economy is slowing. The S&P 500 rose as much as 1.5 percent in the first five minutes of trading on Aug. 5 as the Labor Department said American employers added more jobs than forecast in July and the unemployment rate fell for the first time in four months. The index turned lower on growing speculation that S&P was preparing to strip the U.S. of its AAA rating for the first time.
S&P also said the U.S. rating may be reduced to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt.
The U.S. Treasury Department said there is “no justifiable rationale” for S&P’s move as global finance ministry officials prepared responses to the historic announcement. S&P’s officials stood by their decision and laid blame on a political system that failed to adequately address deficit reduction in the compromise law that President Barack Obama signed Aug. 2 to avert a U.S. default.
‘Further Hit’
“The once-unthinkable loss of the AAA rating will constitute a further hit to already fragile business and consumer confidence,” Mohamed A. El-Erian, chief executive officer and co-chief investment officer at Pacific Investment Management Co., wrote in an e-mail Aug. 6. His firm is the world’s biggest manager of bond funds. “Americans will face higher credit costs over time.”
JPMorgan Chase & Co. estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. A U.S. credit-rating cut would likely increase Treasury yields by 60 basis points to 70 basis points over the “medium term,” JPMorgan’s Terry Belton said on a July 26 conference call hosted by the Securities Industry and Financial Markets Association.
Investors seeking a haven amid concern about the economic recovery have bought Treasuries in recent weeks. Yields on benchmark 10-year notes closed at 2.56 percent Aug. 5, before S&P announced its decision, down from 3.12 percent a month ago.
‘More defensive’
The U.S. downgrade will “reinforce this really uncertain financial market climate that we are confronting right now,” David Rosenberg, the chief economist for Gluskin Sheff & Associates Inc., in Toronto, said in a telephone interview Aug. 6. “You’re probably going to see investors becoming more defensive. That means that they are moving to Treasuries or to cash or to gold.”
Billionaire Warren Buffett said S&P erred when it lowered the U.S. credit rating and reiterated his view that the economy will avoid its second recession in three years. The U.S. merits a “quadruple A” rating, Buffett, 80, said Aug. 6 in an interview with Betty Liu at Bloomberg Television.
“Financial markets create their own dynamics, but I don’t think we’re facing a double dip recession,” said Buffett, chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc. “Clearly what stock markets do have is an effect on confidence, and this selloff can create a lack of confidence.”
Economic Concern
The S&P 500 retreated 11 percent from July 22 through Aug 5. amid concern about an economic slowdown. The benchmark gauge for American equities is still up 77 percent from a 12-year low following government stimulus measures and higher-than-estimated corporate earnings.
Per-share earnings increased 18 percent among the S&P 500 companies that have released quarterly results since July 11, according to data compiled by Bloomberg. About three-quarters of the companies have topped the average analyst profit forecast, the data show. Sales rose 13 percent during that period.
“From an earnings perspective, I’d rather use this environment to be more of a net buyer than a net seller,” David Sowerby, a Bloomfield Hills, Michigan-based money manager at Loomis Sayles & Co., which oversees $150 billion, said in a telephone interview Aug. 6. “The rally that started in March 2009 is still in play.”
Reacting ‘Emotionally’
The decision by S&P to affirm the U.S.’s short-term rating at the top A-1+ level even as it cut the long-term grade from AAA may help to stabilize money markets, according to strategists and economists. While S&P has warned since mid-July that a downgrade was likely, measures of distress in short-term funding markets have declined since then, signaling that traders expect little disruption.
“We were warned,” Rob Arnott, chairman and founder of Research Affiliates LLC in Newport Beach, California, wrote in an e-mail Aug. 6. His firm oversees over $80 billion. “Markets react to surprise and to changes in our expectations. So, markets shouldn’t react much to an unsurprising downgrade. But, a lot of investors react emotionally. So, I would anticipate a lot of volatility, either direction.”
To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net
To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net
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