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How will US debt affect us?

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by Peter Switzer

An overreaction sell-off grabbed the stock market yesterday with the S&P/ASX 200 index down 68.6 points, or 1.41 per cent, following Standard & Poor’s downgrading the outlook for the US Government’s mountain of debt.

Overnight, Wall Street had second thoughts about the stock dumping with the Dow up 65.16 points, or 0.5 per cent, to end at 12,266.75, and the S&P 500 jumped 7.48 points, or 0.6 per cent, to 1312.62. That was its best day in four weeks!

Another headwind

But that said, the S&P warning is just another headwind when it looks like a gale is gathering for the global economic recovery and the bull market.

In summary, what the credit ratings agency was saying is that there’s a chance, albeit a rough one, that the Yank’s debt could be downgraded which could take away their AAA-rating status.

In official terms, their outlook was changed from neutral to negative.

It was also meant to be a warning to the Republicans and Democrats who have been fighting over how the country’s US$14 trillion of public debt will be reduced.

Affect on Australia

So what, you say? Why should it affect us and our stock prices? Well, it works this way: the downgrading pushed higher interest rates and hurts the US recovery which hurts the global recovery and commodity prices slip, then share prices slide knocking onto the Aussie dollar, which also dips.

The Yank’s public debt to GDP is heading to around 80 per cent of GDP by 2013 while ours is, wait for it, tracking towards eight per cent of GDP.

That’s why the Americans have to get ready for a tough budget some time in the future. It doesn’t need to come now as it could derail the recovery but a big plan for next year would be ideal but there is an election coming in 2012.

How long will the rally last?

So it looks like the winner of the US election will have to bite the bullet and whip the US Government’s financials into shape or else interest rates will spike, the share market will dive and we will feel it over here via lower stock prices, a weakened dollar and yes, even higher interest rates until a recession brings lower interest rates. Sounds OK? Well, lower rates will also bring less profits, more bankruptcies and job losses.

I know some experts think the rally has three years but two might be a safer bet.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Wednesday, April 20, 2011

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