With a Treasury default off the table, investors focused once again on economic data. They didn't like what they saw: stalling growth, the prospect of less federal spending to help prop it up, and worsening debt problems in Europe's third and fourth largest economies. And that was before Friday evening's U.S. credit rating downgrade by Standard and Poor's, which said Tuesday's deficit reduction agreement falls short of what is needed to stabilize the government debt problem by mid-decade.
Two weeks of almost daily declines were capped off by Thursday's 513-point hit to the Dow--the ninth worst day in points (though not percentage) in its history--and a roller-coaster Friday. The volatility left all four domestic indices in correction territory, typically defined as a 10% drop. By Friday, the S&P 500 had lost 10.8% in just over two weeks and had broken below a closely watched technical level. It is now down 11.4% from its recent July 7 high, while the Dow industrials have lost 10% in the same time. Both the Nasdaq and the small-cap Russell 2000 lost more than 5% on Thursday alone; the Nasdaq is now down roughly 12% and the small-cap Russell 2000 16.7% since July 7.
The debt limit agreement and global pain in equities helped shore up the reputation of Treasury securities as a refuge for the anxious. The yield on the 10-year bond had edged downward as a debt deal seemed within reach and investor demand sent prices higher, though they nudged upward again on Friday even before S&P's after-hours downgrade.
Last Week's Headlines
The acrimonious debate over raising the Treasury's borrowing authority ended with passage of the Budget Control Act of 2011. The legislation increases the debt ceiling by $2.1 trillion in stages, cuts $917 billion in spending over the next 10 years, and establishes a congressional "supercommittee" that has until Thanksgiving to recommend ways to cut at least another $1.2 trillion from the deficit. Unless it does so, or if Congress fails to adopt those proposals, an additional $1.2 trillion in budget cuts would be implemented beginning in 2013.
For the first time in history, Standard and Poor's downgraded U.S. debt one notch from its impeccable AAA rating to AA+. S&P also reaffirmed its negative outlook for the long term, indicating another downgrade is possible within the next two years. S&P's statement, released hours after Friday's market close, said that "the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed." It also said that the "political brinksmanship of recent months highlights what we see as America's governance and policy-making becoming less stable, less effective, and less predictable." Moody's and Fitch maintained their triple-A ratings, though Moody's also put the United States on negative outlook and Fitch said it will conduct a more thorough review over the next month. Meanwhile, after conferring by phone, leaders of the G7 nations said they were "ready to take action to ensure stability and liquidity in financial markets."
Employers added a better-than-expected 117,000 jobs to the nation's payrolls in July, and unemployment dipped slightly to 9.1%. However, Bureau of Labor Statistics data show that this is the 30th consecutive month in which unemployment has remained above 8%. The private sector added 154,000 new jobs, which were partially offset by the loss of 37,000 government jobs (the ninth consecutive decline).
Yields on the 10-year bonds of Italy and Spain briefly moved above 6%, coming closer to the level at which investor reluctance helped touch off the need for bailouts of smaller countries. Both the Bank of England and the European Central Bank kept interest rates unchanged; the ECB also indicated it will resume buying sovereign bonds, a la QE2.
European uncertainty may have been a boon for the week's Treasury auctions. At one point the 10-year yield had fallen almost 50 basis points from the prior week's 3%, indicating robust demand despite the debt debate, and short-term debt was paying roughly zero.
The Institute for Supply Management's index of U.S. manufacturing activity fell sharply in July, continuing its recent slower-growth trend and hitting its lowest level since July 2009. The 4.4% decline left the ISM index just over the 50% level that separates expansion and contraction. However, at 49.2%, new orders saw contraction for the first time in two years. And growth in the ISM's gauge of the services sector--the largest component of the U.S. economy--slowed to 52.7% from June's 53.3%.
Americans have been taking in a little more money lately, but they haven't been spending it. Incomes were up 0.1% in June, according to the Bureau of Economic Analysis, but consumer spending dropped 0.2% and the personal savings rate rose to 5.4% of income. Wages and salaries fell by $2.2 billion--a far cry from May's $15 billion increase--while income from assets such as interest and dividends increased by $12 billion.
Eye on the Week Ahead
Global markets get their first opportunity to react to the U.S. debt downgrade. And in light of recent weak economic statistics as well as the downgrade, the Federal Reserve's statement will be closely watched for any hints that QE3 might be contemplated.
Key dates and data releases: labor productivity/costs, Federal Reserve Open Markets Committee announcement (8/9); international trade (8/11); retail sales, business inventories (8/12).
Data source: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. Equities data reflect price change, not total return.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.
