US Stock Market Has Fallen 10% Before Rebounding After Credit Downgrades in 2011 and 2023
by Jinta HONG, CFA
Moody's decision to downgrade the U.S. government's credit rating from Aaa to Aa1 has sent shockwaves through global markets. As the last major agency to strip America of its top-tier rating, the move highlights growing concerns over unsustainable budget deficits and rising debt costs.
Moody's cited ballooning deficits and interest costs as key reasons for the downgrade. Moody's said it expects
"Federal deficits to widen, reaching nearly 9% of GDP by 2035, up from 6.4% in 2024, driven mainly by increased interest payments on debt, rising entitlement spending, and relatively low revenue generation."
Market Impact
The markets reacted swiftly in early trading on Monday:
Stocks: The Nasdaq $E-mini NASDAQ 100 Futures (JUN5) (NQmain.US)$ and the S&P500 $E-mini S&P 500 Futures (JUN5) (ESmain.US)$ index futures extended decline by over 1%, and Dow Futures $E-mini Dow Futures (JUN5) (YMmain.US)$ declined 0.55%.
Bonds: Longer-dated Treasury yields rose, with the 10-year Treasury yield $U.S. 10-Year Treasury Notes Yield (US10Y.BD)$ climbing across 4.5% and the 30-year yield $U.S. 30-Year Treasury Bonds Yield (US30Y.BD)$ increasing to above 5%.
Gold: $Gold Futures (AUG5) (GCmain.US)$ rebounded by 1.4% following its largest weekly drop in six months.
Credit strategist Max Gokhman cautioned that rising yields and fading foreign inflows could trigger a dangerous feedback loop, and he points out that this downgrade could lead to a bear steepener scenario, where long-term yields rise faster than short-term ones, whichi could put further pressure on the US dollar and make US equities less attractive to investors.
Historically, credit rating downgrades have led to typically 10% drop and then rebound.
When S&P Global downgraded the US from AAA to AA+ on August 5, 2011, the S&P 500 index fell 10.37% over the subsequent 41 trading days. However, 12 months later, the index rebounded with a 36% gain.
Similarly, on August 1, 2023, Fitch Rating downgraded the US credit rating, resulting in a 10.31% decline in the S&P 500 over 58 trading days. Yet again, the market recovered, posting a 37% increase over the following year.
Wall Street's Reaction
Eric Beiley, Executive Director at Steward Partners Wealth Management, describes the downgrade as a warning signal. He believes that the US stock market, which has recently seen a robust rebound, might be approaching a peak. This sentiment is shared by many on Wall Street, as the downgrade could prompt fund managers to take profits after the recent rally.
Barclays analysts reported that they don't expect Moody's downgrade to notably affect Congressional votes, prompt forced Treasury sales, or influence money markets. Historically, Treasuries have often rallied after such downgrades. They observed that US government credit downgrades have diminished in political impact since S&P's downgrade in 2011, which had limited consequences.
Vasu Menon, OCBC’s managing director of the investment strategy team said in a note.
"It does however reinforce concerns about the growing U.S. budget deficit and debt, but these are not new and have been discussed extensively for the past few months, and even years."
Option Strategy
Long Put: Investors expecting further declines may consider purchasing put options on major indices or specific stocks that could be more vulnerable to economic pressure. This strategy provides downside protection with limited risk (the premium paid for the options).
Covered Calls: For investors holding long positions who wish to generate additional income, selling call options against their holdings (covered calls) can be a way to earn premiums. This strategy is advantageous if you expect the market to remain relatively flat or recover slowly.
Navigating Market Volatility? These ETF Tools Can Help
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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Kevin Travers : Awesome article and graphics!!!
Dan’l : Moody’s is late, and both Gokhman and Kevin Travers are right… excellent work ~;-)
bert 09 :
bert 09 :