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Sovereign Debt Downgrades Accelerate In 2016, And Will Boost U.S. Stocks

Published 07/24/2016, 03:26 AM
Updated 07/09/2023, 06:31 AM

The three main ratings agencies -- Fitch, Moody’s, and Standard and Poor's -- all went on a downgrade spree in the first half of 2016. So far this year, Standard and Poor's has downgraded 16 sovereigns, Moody’s has downgraded 24, and Fitch’s has downgraded 15. All of these represent significant increases over downgrades for 2015, and with many countries on negative watch and marked as proximate downgrade risks, 2016 could well see more negative ratings activity on sovereigns than 2011 did (the last high-water mark).

Most of the countries whose debt has been downgraded are commodity producers such as Brazil, Kazakhstan, Saudi Arabia, and Nigeria. Lower prices for oil and other commodities are still putting pressure on their finances. Developed markets have not escaped, however, with downgrades from various agencies going to the U.K. after its vote to leave the E.U., as well as to Austria, France, and Finland. When Fitch released its mid-year report, the company noted:

“Europe’s political backdrop could have negative implications for sovereign ratings, as fiscal consolidation may drop further down the list of policy priorities. An easing of fiscal policy in the Eurozone has already been evident, prompted by the shift of focus to issues surrounding migration and security, and austerity fatigue. In addition, the fiscal space made available by lower interest rates is not being used to bring fiscal deficits down. Several Eurozone sovereigns have comparatively high government debt levels, which are likely to remain effective rating constraints.”

As global investors absorb the continuing stream of downgrades, it will continue to push their psychology in one direction: towards the United States. U.S. sovereign bonds and U.S. dividend-yielding stocks will continue to attract funds from around the world -- and as we note in our summary for the week, can continue to keep U.S. rates low, and U.S. stock prices high.

Investment implications: The big U.S. ratings agencies have downgraded the sovereign debt of many countries so far in 2016, and with many more countries on a negative watch, 2016 is likely to see more downgrades than the last record year in 2011. This stream of downgrades doesn’t imply that a wave of defaults is imminent. However, it will strengthen the attraction of the U.S. as a destination for foreign fund flows, due to decent economic and fiscal fundamentals in the U.S., as well as positive-yielding sovereign bonds, and dividend-yielding stocks with the potential for appreciation. We continue to be modestly bullish on the U.S. stock market, even though it appears “over-valued” from an historical perspective that neglects other variables. Within the U.S., we favor some big-cap growth companies, as well as big-caps with moderate dividends that investors believe can continue to be successfully delivered.

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