Standard & Poors Places Europe on Negative Credit Watch – World Set for Downgrade!?

standard and poorsI find it rather ironic that Standard & Poors placed the EU-17 on negative credit watch on the same day the market provided the strongest one-day positive assessment to peripheral Europe’s sovereign credit outlook since August (borrowing costs were down sharply on Monday). I have no issue with actually conducting a downgrade of the entire EU-17, but question how this is of any meaning or particular use to investors? Standard & Poors changed its methodology, and incorporated its own political forecasts into the ratings process, which renders the conclusions difficult to interpret. Not that the ratings were of much predictive use in determining credit quality before this change (see 2008). The question now arises; how does one utilize information from a mostly backward looking set of ratio based credit metrics which are combined with (5%/10%/25%/unknown) forecast weighting?

To invest well, one must think.

Standard & Poors attempt to integrate timely political and economic forecasts into their credit rating conclusions will not replace thought or analysis of creditworthiness on the part of investors. When Standard and Poors downgraded the US on Friday, August 5th, 10-year yields fell 17 basis points on the following Monday, as investors conducted their own analysis of US creditworthiness. Warren Buffet came out and called Standard & Poors wrong to downgrade the US because it should be rated “quadruple AAAA”. I agree with Buffet’s assessment and question the meaning of any sovereign credit ratings above the United States? The US has the world’s reserve currency, deepest financial markets, an independent Federal Reserve Board, the Treasury Department, the Securities and Exchange Commission, and the world’s largest military. Standard & Poors justified the downgrade action by including a negative outlook on the US political process. OK fine, but now what’s the point of the rating? Will Standard & Poors incorporate presidential polling data by October into its US sovereign credit rating? When a process sticks to a strict formulaic approach, the results may not be timely, but you know how the conclusions are generated. In order to be relevant real-time, one must; reason, evaluate, analyze, forecast and judge. It is confusing to get this sort of opinion from a ratings agency because they don’t have a track record in this regard.

Continuing to march to the beat of the same drum, Standard & Poors is questioning the political cohesion of the EU-17. Straight from the press release on the downgrade of Germany:

“…Further, it is our opinion that the lack of progress the European policymakers have made so far in controlling the spread of the financial crisis may reflect structural weaknesses in the decision-making process within the eurozone and European Union.”

Where did Standard & Poors go on vacation after the downgrade of US sovereign debt on August 5th? Wasn’t the exact same deeply flawed EU-17 construct in place over the late summer with an inadequate fiscal union and Maastricht Treaty which needed to be changed?

Overnight, the S&P 500 traded lower by about 10 points. Through yesterday, the MSCI World Index had essentially been up for 6 sessions in a row. Over these 6 trading days, global equity markets rose 9.25%. There is still a ton of news to be released this week – the week to “save the Eurozone”. Any excuse to take some profits after a 9.25% 6-day move, in a year which has been as tough as 2011, could be a good enough excuse. But regardless of the ultimate ratings action by Standard & Poors, actual forward looking credit analysis by investors with capital will be how creditworthiness is determined. There is no way around the arduous process of investing and it isn’t something one should attempt to do on auto-pilot.

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