Volatility Gets Political

Terry Flanagan

“In all of the years I’ve been working in the business, I have never felt more uncertain in my life,” said John Alan James, professor at the Lubin School of Business at Pace University. “We really need new leadership.”

Last Friday, August 5, Standard & Poor downgraded the U.S.’s long-held AAA credit rating to AA+, one step downward—a first in U.S. history.

Speculation over S&P’s decision to downgrade U.S. debt can be construed as an attack on policy makers by some market participants. As a result, the market volatility—notably, equities selloff stemming from recent market events—can be attributed to politics, not necessarily economics.

“The sovereign debt situation will expand its impact to the European Union, exacerbated by political wrangling in the U.S.,” said James. He noted that if the S&P is correct about the new credit rating of U.S. debt, markets participants can expect a bumpy ride until the 2012 elections.

“The markets could be further sent down between now and November of 2012—here in the U.S. and beyond,” James said.

And pains will be felt in the capital markets.

“The downgrade will really affect the ETF and money market funds,” said James, who confirmed that some yield is better than no yield for some institutions. “For pensions and endowments, a flight to safety is better in these uncertain times than a mere 25 or 50 basis points.”

Some pensions cannot purchase lower than AAA rated bonds, noted James, making a U.S. debt downgrade all the more significant.

U.S. treasuries have risen in trading volumes due to investors’ flight for safety. Yet, despite difficulties finding competitive yields in any fixed income instruments, equities are subjected to even more pitfalls.

“Equities will go down for a while because of increased market uncertainty and equal or better returns from rising fixed income investments,” said James. “U.S. treasuries will actually increase in attractiveness as Europe and the Eurozone grapple ineffectively with their own multiple sovereign debt problems.

”Futhermore, the dollar will rise in value against the Euro and fall against the Japanese Yen, according to James.

“Nothing of any consequence is going to happen legislatively in the U.S. Congress until the elections in November, 2012,” said James. Policy makers “will never get serious about tackling the deficit and debt problems until they see their careers in jeopardy.

”Perhaps more than ever, politics are crumbling the markets- instilling fear and volatility for investors.

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