World Markets, the Downgrade of US Treasuries and the Eurozone Crisis

I was always told that for any decent piece of written work, you should tell your audience what you’re going to tell them, tell them, then tell them what you told them.

So if you want to cut to the chase and not bother reading the rest of this article, then the message is this: if your long-term investment objectives remain unchanged, then you should not be too distracted by the recent slide in world markets, and remain invested. The last thing you should do is panic and sell in a weak or falling market.

So, what’s been going on? Not for the first time in recent years, world markets have fallen sharply, because of the sovereign credit crisis in the Eurozone, and worries about the US economy.

US Credit Downgrade The highly publicised downgrade of the US credit rating from AAA to AA+ by Standard and Poors was stated to be as much a judgement about the state of the political leadership in the US as well as the overriding sentiment that the proposed solution to the US debt problem is only a temporary fix and is inadequate long-term. There are still concerns about the political will in the United States to deal with the long-term debt of the country, which many feel is becoming too unwieldy for even the biggest economy in the world to handle.

This downgrade in credit rating has preceded an acceleration in the equity market falls over the last few days, most particularly in the US but also around the world including the UK. Strangely, the downgrade in credit rating should have pushed down the price of US Treasuries, but instead the opposite happened because of the falls in the equity markets, and investors turned as usual to Treasuries as a safe haven.

Eurozone Crisis In Europe they have their own debt crisis. Markets waited to see the European Central Bank (ECB) step in and support Spanish and Italian bonds. This failed to happen initially, which triggered a fall in investor confidence about Spain and Italy in particular, but also over the Eurozone generally and whether it can support its ailing members. The ECB support for Italian and Spanish bonds has now apparently come through, albeit a little late.

The combination of the two has pushed worldwide investor sentiment over the edge and brought about some fairly substantial drops in the international equity markets. However, at the time of writing this (Tuesday August 9) I see that initial drops in the FTSE today have reversed and it closed higher than yesterday, and that the S&P500 is already up on the day.

Should investors get out, at least for a while until things improve?

When markets are driven by sentiment and prices are volatile, it is easy to lose confidence and to decide to limit your losses and get out while you still can. This however is almost invariably the wrong thing to do. History has shown us that sharp falls in markets are usually followed by equally sharp recoveries. The classic example is to cite figures which show that someone invested in the FTSE All share index over the past 15 years would have seen returns of 168%, or 6.8% p.a. However, if that investor had been out of the market on the 10 single days of best performance over that 15 years, their return have shrunk to 45% or 2.5% p.a. You will never time the market properly, nor will the highly paid professionals.

So despite current uncertainty in markets, follow the lessons from history and make sure your portfolio is well diversified across different asset classes, that you choose your advisers carefully and see that your portfolio is maintained properly.

Don’t be a forced seller and stick to your long-term plans. You should not panic and sell in a weak or falling market. That advice has proved right in the past and I firmly believe it remains right today.