Reactions to the AA-plus are perplexing but it is exposure that really matters
I must confess to being more than just slightly perplexed – as well as mildly disappointed – by the tongue lashing which Warren Buffett decided to inflict on Standard and Poor’s. Whether or not S&P really has miscalculated the government’s finances by $2,000,000,000,000 says more about the opaqueness of the finances than it does about the methodology of the ratings agency.
This is supposed to be a democracy with checks and balances where the executive is subjected to rigorous supervision by the legislature… and you are trying to tell me that a ratings agency and Treasury can’t agree on such a mere rounding error as two trillion dollars? Tell me, if that is the case, then what chance does a bunch of elected representatives, mainly lawyers, have of scrutinising financial legislation and checking and balancing it?
Buffett went on to suggest that the United States is “quadruple A”. If, Mr Buffett, America is quadruple A, what in your estimation as a value investor does that make Switzerland? Or Singapore? Or Germany? His country has a debt to GDP ratio of 100% and that cannot warrant a Triple A rating, even if it is America. If he had been as slap-dash at valuing stocks as he is becoming at throwing quadruple A ratings around, then he would not be known as the Sage of Omaha.
Mohammed El-Erian, the CEO of PIMCO who knows a lot more about this than Buffett was more realistic in his assessment and when asked, in response to Buffett’s jibe that it was a political move in support of Tea Party politics: “We hope this is a wake-up call, that this is what politicians needed to realise that unless they get their act together, the standing of the US will go down. Unfortunately, this weekend did not speak to that Sputnik moment. We had a very public and unfortunate clash between the S&P and Treasury. That does not help either side. We also have the blame game in Washington about who lost the AAA. They pointed to each other and no one wants to come together yet. Let’s keep our fingers crossed. Early indications are that this has not been the Sputnik moment we need for this economy.”
The response of stock markets tells me that most equity investors still don’t get bonds as they are behaving as though a downgrade from AAA to AA+ will have Washington calling on Athens, Lisbon and Dublin asking for tips. I would have thought that after a decade or so where they were getting all hot under the collar for loading up on debt in order to extract that toxic rubbish called “shareholder value”, that a bit of a downgrade wouldn’t worry them at all. The bonds markets, the ones who should care, seem reasonably sanguine while equity markets are rushing off for a change of underwear. On the other hand, after a 24bp rally in 10-year treasuries, where are President O’Bama’s more expensive mortgage rates? One of Barry O’Bama’s favourite phrases has been that he “works tirelessly” at things; may I suggest he applies some of his tirelessness to regaining AAA status? He is a politician, a fully paid-up professional pursuer of election victories, where he should have learnt the basic truism that perception is reality.
A bond-equity disconnect
Whether Uncle Sam is rated Triple A or Double A is irrelevant unless you pin your colours so firmly to the mast that ratings counts for everything. The last time that happened and investors bought assets based on their Triple A rating alone, we ended up with the biggest financial mess since Adam accepted the apple as a free gift. Forget the rating, make you own assessment of credit.
However, this is all fatuous if you’re exposed with the iTraxx Crossover closing 575/580, the VIX index closing at 48.00 (having closed at 32.00 on Friday) and gold at $1,717.00. Imagine being a Swiss exporter with Euro/Swissy at 1.0700. Friday’s markets were ugly but compared with Monday’s, they could have won the Miss World competition. Confidence is shot to pieces.
I wrote on Friday that this is not a crisis of capitalism but one of socialism. Why markets such as those for equities which trade capitalism in its purest form are trying to commit ((“hairy kary” CHK)) escapes me; unfortunately, so far every buying opportunity seems to have brought more realisable value to the sellers which is not the idea. Wanna know what happens next? Don’t ask me, I haven’t got a clue…. which probably puts me on an even footing with the majority of living Nobel laureates…and Warren Buffett.