Market Strategy - Post the USA downgrade

Politics has incentives that economics cannot under-stand”, said French philosopher Blaise Pascal (the mathematician after whom we know Pascal Law’s). The current turmoil in the world economic scenario due to the downgrade of the US sovereign, which raises fears of a double-dip recession, stands testimony to that.

When the US government decided to raise its debt ceiling after waiting until the eleventh hour, instead of cheering the decision, the markets actually gave it a thumbs-down. The reason that is being bandied about is that the road map prepared by the US for its fiscal consolidation falls short of what would be necessary to stabilise the government’s debt, which touched a level of USD 14.30 trillion. This led to the downgrading of the US sovereign rating by Standard & Poor’s (S&P) from ‘AAA’ to ‘AA+’ and consequently triggered mayhem in the world equity market. Since then, it has been quite a difficult time for investors globally. It looks like the bears have drawn their claws out, and are in no mood to spare anyone. At least, this is what the decline witnessed by global equity indices in the last one week indicates, and India is no exception to that.

To quantify this and put the numbers in perspective, since the beginning of August 2011, the Dow Jones Industrial Average (DJIA) has declined by 11%, the S&P by 13%, the HangSeng by 10%, the Nikkei by nine% and the Shanghai by seven%. During the same period, India’s leading equity indices, the Sensex and the Nifty, also witnessed a decline of eight%. The impact is clearly seen in the advance decline ratio too. Since August 4, there have been seven declines on the BSE, against one advance. The story is no different on a year to date (YTD) basis, and there is hardly any global market that is providing positive returns. In fact, India is the worst-performing market in the Asia-Pacific region, on YTD basis.

It is obvious that when the going gets bad, there are more questions than answers. Many investors have seen their hard-earned money vanish into thin air. Hence, the questions are looming large. What will the exact impact of the downgrade be? Where is the bottom? How much more pain must investors suffer? From what levels will the market bounce back? These are the questions that are playing on the minds of the Indian investors, which have not received answers yet. The investors are now nervously waiting and watching from the sidelines.  As always, DSIJ tries to answer the queries that are clouding investors’ minds, to help them make their strategy during these confusing times.

What Triggered The Meltdown?

Let us first understand what has happened and why. S&P has down-graded the US sovereign rating from ‘AAA’ to ‘AA+’. The reasons cited for the downgrade are as follows. The first is the US fiscal consolidation plan, which falls short of what would be necessary to stabilise medium-term debt dynamics. Secondly, it mentioned that US governance and policy making has become less stable, less effective and less predictable. The worst part is that S&P has further stated that they could lower the long-term rating to ‘AA’ within the next two years, if that the country sees lesser reduction in spending than agreed upon, higher interest rates or new fiscal pressures.