One year after the downgrade: State of the market

CBS/iStockphoto

(CBS) One year ago today, President Obama announced the end of a rancorous round in the ongoing political boxing match over the debt ceiling. The fight illustrated just how dysfunctional our federal government had become, and raised serious questions about the ability of our leaders to compromise to solve problems.

I happen to remember the story well because I'd left for vacation right before the debt ceiling deadline; and while I was away, Standard & Poor's downgraded United States debt from AAA to AA+ and U.S. stocks fell 14 percent in a matter of weeks. Given those events, that turned into a working vacation. I'm on vacation again this week, so you may want to brace yourself for stock market turmoil.

I'm hoping there's no breaking news to cover this week, but it's worth looking back to see what has happened since those stormy summer weeks last year when Congress was in the thick of a battle over raising the debt ceiling. The lessons here may come in useful the next time the market goes into freefall. 

Debt Ceiling

Market Stats prior to debt ceiling deal (7/29/11):

The president announced the debt ceiling deal on Sunday, July 31, and Congress approved it by the Aug. 2 deadline. That agreement laid the foundation for the Joint Committee on Deficit Reduction (aka "the supercommittee") comprised of 12 members: Six from each chamber, equally divided between Democrats and Republicans.

There were high hopes for the supercommittee, but now we know that the members failed to come to an agreement. As a result, as of 2013, there will be mandatory across-the-board spending cuts matching the size of the debt ceiling increase, or $1.2 trillion. (This is one component of the "fiscal cliff" that is terrifying economists.) The cuts will be split between defense spending and non-defense programs, but benefits from entitlements including Social Security, Medicaid, Medicare -- as well as veterans benefits -- are exempt.

S&P Downgrade

Market Stats prior to S&P downgrade (8/5/11):

The week following the debt ceiling deal was a nasty one for stock investors and that was before S&P downgraded the credit rating of U.S. sovereign debt for the first time ever. The S&P 500 plummeted 7.1 percent, the largest weekly percentage drop since the week ended November 21, 2008. On August 7, 2011, I wrote:

"In case you were under a rock, in a week where DC lawmakers finally reached a deal on the debt ceiling, investors finally realized that two bigger problems exist for global markets: (1) growth has slowed down and doesn't seem poised to pick up any time soon and (2) the European debt crisis is far from solved, as the malignancy appears to be spreading to Italy and Spain."

Yikes, that sounds a little too familiar!

On the Friday after the rotten week culminated (Aug. 5, 2011), S&P announced the downgrade. The ratings agency took some heat for the action, but it was more of a symbolic blow and rebuke of politicians than anything else. In fact, bond investors shrugged off the downgrade. On the trading session before the downgrade, the yield on the 10-year Treasury bond was 2.58 percent and on the day after (Aug. 8), bonds prices increased and yields fell to 2.4 percent.

Additionally, mortgage rates fell to what were then all-time lows of 4.15 percent for 30-year loans and 3.36 percent for 15 year loans.

In the week following the downgrade, markets gyrated in a way that hearkened back to the bad old days of the financial crisis. Investors absorbed four gut-wrenching days, where stocks see-sawed by more than 4 percent on consecutive sessions. Although the damage on the week amounted to a total of 2 percent losses, bruised investors headed for the sidelines.

Market Stats week after S&P downgrade (8/12/11):

Stocks kept sliding for another week, bringing the four-week loss to 14 percent. Markets made progress, but then succumbed to a bout of selling in the fall, before bottoming for the year. One year later, the same problems loom large for the global economy: Eurozone officials have not created a plan to prevent the spread of the European debt contagion to Italy and Spain and global growth is sputtering. But if you pulled out of the markets, you missed a nice rally. 

Here's where we stand one year after the cruel combination of the debt ceiling deadline and the S&P downgrade:

Market Stats (7/27/12) and performance from a year ago:

[Dreadnut]

Any rise in the stock market can be directly attributed to forecasts of Obama's impending defeat.
If Obama were to rise in the polls substantially, the stock market would crash.

[wfw3536]

What I find funny is when Obama ran in 2008 he said Bush was incompetent and it wasn't fair to our children that Bush ran up 4 trillion in new debt in 8 years. Well, Obama has run up 5 plus trillion dollars in less than 4 years, and his own administration projects this to continue for several years. We just can't afford another 4 years of this out of control spending.

[hypnotoad72]

Give Cantor another chance:

http://www.salon.com/news/politics/war_room/2011/06/27/eric_cantor_conflict_of_interest/index.html

[karek40]

I would have appreciated a "guess" as to our next rating AAA, AA+, or perhaps AA or perhaps even just A. Wait until the worlds largest refrinery comes on line in Saudi and watch as the petro dollar disappears.

[lami987]

Its good news for a great number of working Americans who has 401K at their work place. But American job situation cannot improve until America can stop outsourcing jobs not just by Bain and many Romney wannabes but also by many American global corporations. Worse yet if they hide their money in those tax havens like Cayment Island, Swiss banks etc.

[hypnotoad72]

I hate to say it, but booooCBS has a point. Both parties, to varying extents, have been complicit.

The question is, which party is more likely to fix things?

Now, factor in who kept wanting to raise the debt ceiling, as cited in example A:

http://www.govtrack.us/congress/votes/108-2003/s202

I think I'll vote Democratic this time. Even if both sides lobby elected officials for personal gain.

And Obama has one defense: "Chess". After all, he has coopted and used GOP policies, suspecting that the GOP would berate him one way or the other, as would his supporters.

If Obama is some grand player, I'll wait for the debates to play the obvious trump cards and checkmate moves he's got.