Bloomberg News

Stocks Sink, Treasuries Rally on U.S. Rating; Gold Hits Record

August 08, 2011

Aug. 8 (Bloomberg) -- U.S. stocks sank the most since December 2008, while Treasuries rallied and gold surged to a record, as Standard & Poor’s reduction of the nation’s credit rating fueled concern the economic slowdown will worsen. The Dow Jones Industrial Average plunged 634.76 points as approximately $2.5 trillion was erased from global equities.

The S&P 500 Index lost 6.7 percent to 1,119.46 at 4 p.m. in New York, its lowest level since September, as all 500 stocks fell for the first time since Bloomberg began tracking the data in 1996. The Stoxx Europe 600 Index slid 4.1 percent to extend a drop from its 2011 high to 21 percent. A surge in Treasuries, benchmarks of the nation’s $34 trillion debt market that is more than twice the value of American equities, sent the 10-year note yield down 22 basis points to 2.34 percent, the lowest since January 2009, and the two-year rate slid to a record low. The S&P GSCI commodities index lost 3.9 percent.

Equities extended losses after the ratings cut prompted S&P to also lower debt rankings on Fannie Mae, Freddie Mac and other lenders backed by the government and reduce the credit outlook on Warren Buffett’s Berkshire Hathaway Inc. to negative. President Barack Obama, breaking his silence on the downgrade, said the main obstacle facing the U.S. is “lack of political will in Washington” to solve the country’s problems.

“If you’re an investor and you say ‘I’m worried about what’s going on in the world, I’m worried about liquidity and safety,’ you basically have no place to go other than the Treasury market,” Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, said in a telephone interview. His firm oversees more than $38 billion. “As for stocks,” he said, “you don’t want to catch a falling knife. But if we see value, we might be using this as an opportunity to add to specific positions.”

Flight From Risk

On the first trading day after the S&P downgrade, investors retreated from riskier assets on concern the global economy will slow further. They poured money into haven assets such as Treasuries, gold, and the Swiss franc, while benchmark equity indexes for Europe, Australia, China and smaller U.S. companies extended losses to more than 20 percent from recent peaks, the level some investors consider a bear market.

Spanish and Italian bonds were exceptions as yields on 10- year notes slid after the European Central Bank bought the debt to help stem the spread of the region’s government-debt crisis.

The S&P 500’s three-day slide of 11 percent is the worst since November 2008 when the market was still reeling from the bankruptcy of Lehman Brothers Holdings Inc. The gauge has plunged about 17 percent since July 22 to mark the worst drop in the same length of time since March 2009, during the final days of the bear market that dragged the index to a 12-year low.

More than 30 stocks fell for each that rose on U.S. exchanges in the broadest selloff since Bloomberg began tracking the data in 2004. Almost 18 billion shares changed hands on the nation’s bourses, the most since the market crash of May 6, 2010, when more than $860 billion of equity value was wiped out in 20 minutes before stocks pared losses.

‘Fear and Panic’

“This is fear and panic,” Don Wordell, a fund manager for Atlanta-based RidgeWorth Capital Management, said in a telephone interview. His firm oversees about $48 billion. “I don’t feel like the economy is falling off as quick as the stock market is. Still, you’re going to have to be patient. The short-term rating of the U.S. government was not changed. Long-term ratings were. There’s no liquidity issue. I don’t think this is a flash crash.”

An index of financial companies in the S&P 500 tumbled 10 percent as a group, plunging the most since April 2009 and reaching the lowest level in two years. Bank of America Corp., Citigroup Inc., Morgan Stanley, SLM Corp. and Genworth Financial Inc. lost more than 14 percent to lead the declines. Goldman Sachs Group Inc. sank 6 percent to $117.66, below the firm’s tangible book value of $121.60 per share as of June 30.

Berkshire Credit Outlook

Berkshire Hathaway’s Class B shares fell 6.5 percent to $66.65, the most since 2008. Buffett’s company is among firms that may be downgraded by S&P as the ratings company reviews insurers following its reduction of the U.S. rating.

“Our view of these companies’ fundamental credit characteristics has not changed,” S&P said in a statement today as it cut the outlook to “negative” on Berkshire. “Rather, the rating actions reflect the application of criteria and our view that the link between the ratings on these entities and the sovereign credit ratings on the U.S. could lead to a decline in the insurers’ financial strength.”

‘Quadruple A’

Buffett said S&P erred when it lowered the U.S. credit rating and reiterated his view that the economy will avoid its second recession in three years. The U.S. merits a “quadruple A” rating, Buffett, 80, chairman and chief executive officer of Berkshire, said in an Aug. 6 interview with Betty Liu on Bloomberg Television.

The U.S. Treasury Department said there is “no justifiable rationale” for S&P’s move. Officials from the ratings company stood by their decision and laid blame on a political system that failed to adequately address deficit reduction in the compromise law that Obama signed Aug. 2 to avert a default.

Yields on the home-loan bonds of the biggest U.S. mortgage companies Fannie Mae and Freddie Mac jumped to the highest relative to U.S. Treasuries in more than two years. Fannie Mae’s current-coupon 30-year fixed-rate mortgage-backed securities rose 0.03 percentage point to about 1.11 percentage point more than 10-year U.S. government debt as of 12:15 p.m. in New York, according to data compiled by Bloomberg.

S&P plans to release later today reports on asset classes, including municipal bonds, affected by the U.S. downgrade, said John Chambers, head of S&P’s sovereign ratings committee.

Strategist Calls

The loss of America’s AAA rating at S&P may spook investors and cause sentiment to grow more bearish in the short term before corporate fundamentals, including balance sheets with more cash than debt, and earnings growth continue to push the S&P 500 higher by the end of the year, strategists at Barclays Plc, Citigroup Inc. and JPMorgan Chase & Co. said in reports to clients. While Goldman Sachs cut its year-end estimate for the S&P 500 to 1,400, Barclays held its 1,450 estimate.

“The medium to long-term effects of the U.S. sovereign downgrade are minimal, even as the short impact could be turbulent,” Thomas Lee, JPMorgan’s equity strategist in New York, wrote in an e-mailed note.

Demand for equity options to protect against further losses soared. The VIX, as the Chicago Board Options Exchange Volatility Index is known, surged 50 percent 48, the biggest jump since 2007 and the highest level since the day the S&P 500 bottomed on March 9, 2009. Europe’s volatility index rose for a record ninth straight day. Hong Kong’s HSI Volatility Index advanced 6.1 percent to the highest since May 2010. Kospi 200 Volatility Index surged as much as 59 percent for a record intraday gain.

Reserve Currency

The downgrade of the U.S. to AA+, the first time the country lost its AAA status at S&P, leaves its debt rated two steps higher than Japan and China. Fitch Ratings last week affirmed its AAA U.S. ratings. Japanese Finance Minister Yoshihiko Noda said U.S. Treasuries were still attractive.

Moody’s Investors Service reiterated today that it affirmed the U.S. government’s top Aaa ranking because the dollar’s status as the main reserve currency allows it to support higher debt levels than other countries, the rating firm said today in a report.

The two-year yield fell as much as six basis points to a record low 0.2283 percent before trimming its decline and ending at 0.26 percent. The five-year Treasury yield slipped 16 basis points to 1.09 percent. While Treasuries rallied, credit-default swaps insuring U.S. debt for five years rose one basis points to 56.36, according to data provider CMA, compared with a more than two-year high of 64 on July 28.

The dollar depreciated 1.7 percent against the Swiss franc and earlier weakened as much as 2.5 percent to a record 74.83 centimes. The dollar dropped 1 percent against the yen, which strengthened against all 16 peers except the franc. The currencies of Australia and New Zealand declined against most peers.

European Shares

Industrial and banking shares led losses in Europe, with 34 shares falling for each that rose in the Stoxx Europe 600 Index. Bank bonds in Europe are the riskiest ever as the ECB was said to be snapping up Italian and Spanish government debt whose soaring yields hurt lenders already nursing Greek writedowns. A benchmark index of credit-default swaps on European banks and insurers jumped to a record 219 basis points, according to JPMorgan Chase & Co.

Spain’s 10-year note yield slid 88 basis points to 5.16 percent. Greece’s yield decreased 15 basis points, with the similar-maturity Irish yield retreating seven basis points. The cost of protecting western European government debt against default fell 6 basis points to 280, according to the Markit iTraxx index of credit swaps.

ECB Moves

The ECB said it welcomed efforts by Spain and Italy to reduce their budget deficits and said it will “actively implement” its bond-purchase program, according to a statement issued in the name of the ECB president after an emergency Governing Council conference call last night. The ECB bought Italian and Spanish bonds, according to five people with knowledge of the transactions.

“The ECB buying the bonds of Italy and Spain seems to be the new great hope for the politicians and markets generally,” Gary Jenkins, a strategist at Evolution Securities in London, wrote in a research note. “They will have to be prepared to buy an awful lot of them. And the trick is to buy enough to show such a commitment to a certain yield level that investors feel comfortable buying alongside.”

The MSCI Emerging Markets Index retreated 5.3 percent, the most since November 2008 on a closing basis. The gauge has dropped 14 percent since Aug. 1, set for its biggest five-day decline since 2008. China’s Shanghai Composite Index tumbled 3.8 percent. India’s Bombay Stock Exchange Sensitive Index lost 1.8 percent, while Russia’s Micex Index 5.5 percent.

Gold futures climbed as much 4.3 percent to a record $1,723.40 an ounce and silver jumped as much as 5.3 percent to $40.39 an ounce. Goldman Sachs raised its forecasts for gold futures to $1,645 an ounce, $1,730 and $1,860 on a three-month, six-month and 12-month horizon as it expects real U.S. interest rates to stay lower for longer.

Oil declined 6.4 percent to an eight-month low of $81.31 a barrel in New York. Zinc, nickel, lead and wheat also lost at least 3.9 percent to helplead declines in the S&P GSCI. Of 24 materials tracked by the index, only gold, silver and natural gas advanced.

--With assistance from Jeff Kearns, Whitney Kisling, Christine Harper and Jody Shenn in New York, Shiyin Chen in Singapore and Claudia Carpenter, Andrew Reierson, Michael Patterson and Daniel Tilles in London. Editors: Michael P. Regan, Chris Nagi

To contact the reporters on this story: Stephen Kirkland in London at skirkland@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Michael P. Regan at mregan12@bloomberg.net


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