Positives from negative

28 April 2011 | By Chris Salih

Advisers say Standard & Poor’s decision to downgrade its credit rating outlook for the US from stable to negative should not deter investors from the market.

Last week, S&P warned that the US must address its ballooning deficit by 2013 to hold on to its AAA rating. Among S&P’s concerns is the material risk that US policymakers might not reach an agreement on how to address medium and long-term budgetary challenges by 2013. The deficit is expected to reach $1.5trn next year and total debt stands at $14trn.

S&P says despite “exceptional strengths”, the US fiscal position has “deteriorated steadily” over the last decade, particularly in the wake of the financial crisis.

The news rocked markets initially, with the FTSE 100 falling 2 per cent and the Dow Jones down 1.6 per cent.

Cavendish Asset Management North American fund manager Tim Roberts says the news is bad for markets but the rationale for the move is obvious, given the US fiscal profile looks ever weaker.

Roberts believes it is not time for people to panic. He says: “It is unlikely S&P will downgrade US debt over the coming years. The US will continue to repay its debt and will eventually get itself back on a firmer fiscal footing.

“This should serve as a shot across the bow to the politicians on Capitol Hill who are currently playing political brinksmanship over the budget, putting further pressure on them to agree a deal.”

US plans to grow its way out of the fiscal deficit have worked to an extent by lowering unemployment levels and inflation has risen from low levels. However, the plan has been contro-versial and both the Democrats and Republicans have developed their own solutions to tackle the deficit.

The Republicans, which control the House of Representatives, have drawn up a plan that looks to bring the deficit down by $6.2bn over the next 10 years through cuts to health and social programmes, something the Democrats believe will hit the elderly too hard.

Earlier this month, president Obama unveiled an initiative to cut the deficit by $4trn over the next 12 years. He wants cuts to defence spending combined with higher taxes on the wealthy.

F&C director of UK strategy Ted Scott says both parties recognise that populist monetary and fiscal measures, such as tax cuts, are not sustainable but the concern is that both parties cannot come to an agreement on how to tackle the debt.

He says: “It is this fear of a lack of political consensus that led to S&P downgrading its outlook as much as the state of US finances.

“S&P also said it could lower its long-term rating on the US within two years, which is earlier than analysts were expecting.”

The news comes at a time when investors have just started to plough money into the IMA North American sector.

Sales in North American funds jumped more than fivefold in February to a record £222m, compared with the £41m average for the last 12 months.

The sector was the fourth-best seller in February, behind strategic bonds, UK absolute returns and the global sector. The US was 25th on the list in January.

Skerritt Consultants head of investments Andy Merricks says his firm has bought its first US fund, a US smaller companies exchange traded fund.

He says: “We think there is a bit of an opportunity as the downgrade possibility has been well flagged up. If there are opportunities, that means smaller companies are likely to lead a bounce.”

Hargreaves Lansdown investment manager Ben Yearsley says: “The downgrade will only have an impact on certain sectors and it is a fund manager’s job to navigate away from those dangers.

“The spending cuts are likely to come in the defence and medical/ healthcare sectors and there will be effects. But there are so many global brands, such as Coke and Microsoft, which are sound long-term companies.”

Yearsley says he only gets exposure to the US through technology funds but that he would not deter anyone looking to invest in the US as a whole.

He says: “The economy is not struggling any more than most. The US debt to gross domestic product is not as bad as it is in the UK, for example.

“The biggest problem for UK investors is that there are very few good long-term managers in the US. We use M&G North America and Schroders US mid-cap.”

Bestinvest senior investment adviser Adrian Lowcock agrees the news was unsurprising. He says it will kill off any further possibility for quantitative easing and puts the emphasis on financial discipline.

He says a downgrade would slow the global recovery and the dollar may come under pressure, which may have an impact on US inflation.
He says: “Mild inflation can be good for shares but high inflation, driven by price rises as opposed to wage rises, is not good. With rapidly rising costs, companies will struggle to pass on price rises to the consumer.

“Consumers are not getting an increase in their incomes and will instead buy cheaper goods or forego the purchase completely.”

If you enjoyed this article, sign up here to receive daily email updates from Money Marketing and Follow @_moneymarketing