On Friday, credit rating agency firm S&P downgraded a handful of European nations, which included stripping France of its AAA credit rating. The S&P didn’t stop there though, on Monday the firm then downgraded the EFSF (the fund that has been set up to help debtor nations like Greece) from AAA to AA as well. We pointed out the EFSF’s flaws in this commentary back in October, so we’re not too surprised by this development. Nor were we surprised by the downgrades handed out to numerous EU countries. Apparently, we’re not the only ones.
The market is a very complex. As soon as information becomes available to the market, it immediately starts to determine how such information will impact future market conditions. More than that, the market wastes little time in accounting for such potential impacts. So when the debt crisis started in Europe and yields in many nations (not just Greece) started rising, the S&P came out and said many of those nations’ debt holdings would be reviewed and placed on credit watch. Reading between the lines (downgrades were coming) the market starting accounting for the impact of such downgrades.
That’s the reason we didn’t see the market sell off 200-400 points on Friday. We already saw the market accounting for all of these downgrades, it was called August-October. Then when the EU put forth the plan of the EFSF the market had new information to analyze and factor in or “price in” to the market. Again, the market is no dummy, and when studying the structure of the EFSF (read the linked in article above), it wasn’t hard to realize that this fund may be a target of downgrades as well.
Fast forward to the S&P downgrading the EFSF and what did European markets do? They were widely unchanged to up sharply. The German Dax composite rose over 1% Monday. Why? Because the news that is supposed to tank markets was already known, it was just a matter of time before it became official. In other words, the market didn’t learn anything new (good or bad) and have to adjust its price for the new information. So what new information might move the markets you ask?
Greece could come back into focus. The markets have kind of looked past Greece recently, somewhat assuming that the problem had been solved, at least temporarily enough so, to keep it out the news for now. Belgium and Spain have seen their 10 year bond yields decrease dramatically from their mid November peaks, so another rise in those yields could worry the markets. Political disruption in the EU as far as the best way to handle debt crisis’ in Italy or Greece or any other country for that matter could also provide jitters.
Keep in mind the markets are at the top ends of their recent ranges. Therefore news like this could be the catalyst to start a sharp pullback. Remember, the news isn’t as important as the price at which the news is received (i.e. where is the market at when news is absorbed). We outlined negative catalysts as those are the most obvious when near the top end of the range. The contrarian view however, would be that any slight positive development could enthuse the markets enough to vault to fresh 5/6 month highs. Be prepared for both but do not overreact to something you already know.
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