Market Environment | August 2011

Market Intelligence

On August 5, Standard & Poor’s (S&P) announced that it downgraded the U.S. sovereign credit rating by one notch, to AA+ from AAA. S&P also attached a negative outlook to the new AA+ rating. Here are some perspectives and valuable insights from our team of global investment experts.

Horacio Valeiras Chief Investment Officer Allianz Global Investors Capital			The S&P decision had generally been expected. The ratings agency was not shy about its comments on the debt deal. In the short run, economic data is a more important determinant of the market’s direction, and much of it looks weak. However, the market is not expensive in terms of valuations, earnings have been good and corporations have strong balance sheets. The debt situation in the U.S. is nowhere near what we see in Greece or Italy, and even though the downgrade was expected, interest rates went down last week. We are still in the camp of owning equities in this environment, but my expectation is that dividend-payers and free-cash-flow-generating companies are the ones that will outperform.


Ben Fischer Founder and Portfolio Manager NFJ Investment Group			The resulting tumult from S&P’s downgrade should be viewed as a buying opportunity for value-focused investors. We intend to buy into weakness in the markets. Dividend-paying stocks, in particular, are attractive in that investors can earn income while the market sorts out the uncertainty over debt issues—both at home and abroad. Long-term, U.S. companies have terrific balance sheet strength. However, there isn’t going to be a whole lot of growth. We’re not in a recession but we’re also not in an expansion environment either, unless we get some sort of QE3. Without the government actively involved the economy doesn’t have the wheels to do what we’ve done in past cycles, which is grow at 3% to 4%. Psychologically, there’s going to be a lot of fear. There might be some hesitation as the scare headlines hit but longer term I think people realize that we’re going to survive. This presents a timely opportunity for company management teams to use that cash on their balance sheets to send a powerful message to shareholders by raising the dividend.


Douglas Forsyth Portfolio Manager Allianz Global Investors Capital			Fear and uncertainty almost always have a greater impact on market psychology than fundamentals. It appears that S&P's action was more weighted on the political fighting and lack of focus among politicians as much as it was a statement about future financial conditions. There are multiple flaws and inefficiencies in the rating agencies’ processes, which was again proven when S&P made a $2 trillion miscalculation in their release on Friday. Let's remember the vast number of AAA ratings they had on synthetic, hyper-levered securities that were among the primary causes of the crash of the financial system in 2008. It may be that the majority of the market’s reaction to these concerns are already priced in. We shall see what the actions of the market are in the very short term, but S&P’s action clearly does not change our long-term outlook for U.S. high-yield bonds. If we are to take the downgrade at face value, then Treasury rates in the U.S. should go higher. Further, we believe that U.S. high-yield bonds are an excellent diversification tool in a rising-rate environment.

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