Worth Less, but Not Worthless

Markets were sent tumbling yet again, with the Dow closing down 5.5% and the Nasdaq and S&P losing more than 7%, on Monday. The latest gunshot to spook the investor herd was Standard & Poor’s downgrade of the U.S. debt rating from AAA to AA+.

The rationale for the downgrade, essentially, was the inability of Washington lawmakers to get along and come up with a debt reduction plan that the rating agency deemed acceptable. No matter how much political dissention there is, however, squabbling on Capitol Hill should have nothing to do with the U.S. credit rating. To think otherwise would be like a bank raising the interest rate on a home mortgage simply because a couple doesn’t eat dinner together most nights or argues over who left the cap off the toothpaste. It’s all about the ability to pay, which is not an issue for U.S. debt.

The irony of it is, in the wake of the downgrade, U.S. Treasuries remained the safe haven, which meant the government’s borrowing costs did not go up. In fact, they went down. Unfortunately equities, the unintended victim, were trounced substantially because investors sold first and asked questions later.

Investors had already been running scared because of worries from European debt to whether a slowing U.S. economy will slip back into recession. The real reason for their panic, I would argue, has very little to do with debt levels in Greece or Italy, or whether GDP in the U.S. will drop into negative territory. It’s all about 2008.

Investors remember all too well the great flush that occurred in the midst of the financial crisis, when huge companies that had been thought to be rock solid--Bear Stearns and Lehman Brothers, to name two--suddenly went out of business. Asset values evaporated, and investors feared a return of the Great Depression.
Now as fears ripple through the market, investors vow not to be caught flatfooted again. “I’m not going to let that happen to me” is the mantra as they head for the hills, taking their cash with them.

The good news is this is not 2008. Not even close. The economy is still growing. GDP for Q2 2011 was up 1.3%. Although that’s hardly strong growth, it’s a far cry from a negative reading of -6.8% for Q4 2008. Yes, employment is soft, but we are adding jobs, even in the midst of government layoffs. Just a few years ago, the monthly job reports were showing losses of 500,000 jobs.

Demand is weak as consumers deleverage, while the government, which can account for 20-30% of GDP, has cut its spending by mandate. This could set the stage for a soft economy to go into recession, but don’t look for things to fall off a cliff.

The simple fact is we’re two years into an economic recovery and we’ve hit a soft patch, which is to be expected. We’ll either start growing from here, or slip into a recession again. Only time--and economic data--will tell. In the meantime, assets are worth less, but they are not worthless. This is far more important than a clever play on words. It is a statement of fact that this is not 2008 all over again. We are in an economic slowdown/recession, not a crisis. No big corporations are about to implode and go out of business.

Although these are painful times to be an investor, when fear grips the market with increased volatility, but there really is no reason to panic. The economy may be wounded, but it’s been on the mend and, for the moment, there is no reason to believe the patient needs to be in intensive care. And if you are looking for the right medicine to make you feel better then look no further then the dividend yield on the S&P 500 which is yielding about as much as the US 10 year treasury. Historically when that has happened in the past equities have had a very nice rally.