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Downgrade Drama

Well we've done it. It's official. The partisan bickering in Congress has managed to snatch defeat from the mouth of victory. I have written that I find it incredibly ironical that if S&P had done their job properly in the years of 2000 - 2007 we would not find ourselves in this economic morass. When the banks were selling these toilet paper mortgages, toxic assets and bundling them together as CDO's who was stamping them "AAA"? S&P. S&P is a culpable for the collapse of the economic system as any of the greedy bankers. In my opinion they are more to blame. It was their job to make sure that this kind of greed and arrogance would not be tolerated. Instead they were willing co-conspirators in this fraud that was perpetrated on the ill educated middle class.

So we are here now. The S&P removed the United States from its list of risk free borrowers for the first time in history Friday night. You can read the entire S&P Report here. This downgrade is fraught with symbolic significance but carries a few crystal clear financial messages. It characterized the downgrade as a judgment about our political leaders. It is clear that the divergence between our political parties had reduced the world's confidence in our government to manage our finances. In my reading of the report I conclude that the downgrade reflected the effectiveness, stability and predictability of the American political institutions during this time of ongoing fiscal and economic challenge.

Pathetically, President Obama's administration reacted as scripted, with indignation stating that S&P had made a mathematical error by overstating the debt by $2 trillion. Excuse me Mr. President but that seems like a pretty big mistake for anyone to make. Exactly how many zeros are there after the 2 for 2 trillion?

The official story is that on Friday, after the market had closed S&P notified the Treasury of its intention to issue a downgrade and sent the department a copy of the announcement which is standard procedure. Within an hour a staff member noticed the $2trillion dollar mistake and called the company and explained the problem. About an hour later the company conceded the problem and issued a new release but with new numbers and the same conclusion. Saturday S&P released a terse statement attributing the error to a change in assumptions in its methodology but that it had no impact on the rating decision - "AA" it will remain. Indeed in the release on Saturday S&P warned that the government needed to make progress paying its debts in order to avoid further downgrades.

The truth is that the credit rating agencies have been trying to restore their credibility since they got caught with their hand in the cookie jar of the economic collapse of the banking system. A Congressional panel called them "essential cogs in the wheel of financial destruction" after their greed and avarice led them to stamp the garbage CDO's "AAA". There are many who see this as a ploy by S&P to clean their tarnished image by pouring gasoline on the fire. Well if they wanted to get everyone's attention it worked. In my opinion they just look like bigger fools than ever. Indeed, S&P are confronting many investors who consider U.S. Treasuries to be the safest investments in the world. It seems to me that S&P is on a suicide mission. They seem to be even dumber than I thought. As they seem to be on the fast track to become irrelevant as soon as possible.

So who will suffer the most? The middle class will, of course. The bad news for the middle class will be that the downgrade might cause investors to demand higher interest rates causing the ripple effect of higher borrowing costs for small businesses, credit card debt, car loans, home mortgages there by slowing the rate of the already tepid economic recovery. This is exactly what we don't need now. In fairness Moody's and Fitch have not downgraded out rating so many analysts are hoping that the impact to our economy is modest.

As I have often written, I do not like words like hope or wish. I trade the market on probabilities and with the Israel market closing down 6% what do you think the probability is that we will see a bounce in the market tomorrow. I give it a 10% chance.

There will be Dark Days ahead as there will need to be massive tax hikes and / or massive cuts to entitlement programs. There will be hikes in the age of retirement eligibility and cuts in Medicare. Both programs long believed to be sacrosanct. Yes there will be massive cuts to our national defense budget as well.

Somehow I doubt there will be any cuts in the pay of congressmen or any cuts in their health care or retirement programs. Just call it a gut feeling.

So how do we play this market today? As you all know the S&P downgrade came after the market closed on Friday, the S&P 500 futures remained down only two points for the first few minutes after the news broke and ended the after-hours session only five points lower. That's because the news event was initially met with a mild response.

Today, however, Middle Eastern markets closed sharply lower. Asian Markets closed lower and European markets have opened lower. It is difficult to see how this unusual news event will play out here. The trading recommendation for tomorrow and Tuesday is traders should stand aside. It is important to realize that bad news following a large sell-off may well produce a bottom. The difficulty, of course, is determining the level at which the bottom will occur. Be patient and sit on your hands. With The Silver ETF (SLV) if the market pulls back to $32.50 buy in. If GLD pulls back to $145.00 buy in otherwise don't buy anything. Sometimes Doing Nothing is Doing Something!

 

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