One year after the downgrade: State of the market

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(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):

  • DJIA: 12,143
  • S&P 500: 1,292
  • NASDAQ: 2,756
  • 10-Year Bond Yield: 2.82%

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):

  • DJIA: 11,444
  • S&P 500: 1,199
  • NASDAQ: 2,532
  • 10-Year Bond Yield: 2.58%

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):

  • DJIA: 11,269
  • S&P 500: 1,178
  • NASDAQ: 2,507
  • 10-Year Bond: 2.24%

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:

  • DJIA: 13,075: +7.7%
  • S&P 500: 1,385: +7.3%
  • NASDAQ: 2,958: +7.3%
  • 10-Year Bond: 1.55%: yield: -1.25%
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    Jill Schlesinger, CFP®, is the Emmy-nominated, Business Analyst for CBS News. She covers the economy, markets, investing and anything else with a dollar sign on TV, radio (including her nationally syndicated radio show), the web and her blog, "Jill on Money." Prior to her second career at CBS, Jill spent 14 years as the co-owner and Chief Investment Officer for an independent investment advisory firm. She began her career as a self-employed options trader on the Commodities Exchange of New York, following her graduation from Brown University.