By JACK HOUGH
On Monday, investors> who worry about a sharp worsening of America's fiscal condition got a quick glimpse at how such a downturn might affect their portfolio holdings.
Standard & Poor's on Monday lowered its outlook on the U.S. to negative from stable -- a first -- citing a failure by policymakers to stem deficits and a fiscal profile that is deteriorating relative to peer nations. The move leaves the nation's AAA credit rating intact for now but suggests it might be lowered within the next two years. If that happens, it might reduce the world's appetite for Treasury bonds, causing prices to fall and yields to rise -- and making future refinancing of the nation's debt far more costly.
Adding to the tension, growing talk of a debt restructuring in Greece (by way of partial default) has sent bond yields there soaring in recent days. Ten-year Greek bonds now yield more than 14%, versus 3.4% for 10-year U.S. Treasurys.
Stocks broadly plunged -- the Dow closed down 140 points -- and gold gained on the news as investors fled risk and clutched real assets. There were a few surprises, however.
Surprise 1: Treasurys rose slightly.
Short issues gained more than long issues and nothing soared, but the result was significant. The mere hint of a bond downgrade typically sparks a selloff, but U.S. issues benefitted from their critics. Why? Here's a theory: Lawmakers on both sides have proposed significant spending cuts in recent weeks, but the conversation in Washington has consisted of too much chest-thumping and math gimmickry and too few specifics. The threat of a downgrade gives lawmakers another reason to get serious, fast, and because financial markets look to the future rather than the present, the warning on Treasurys might have been seen as good news.
Takeaway: U.S. fiscal problems are fixable, and the probability of improvement might be getting better, not worse.
Surprise 2: Gold didn't lead.
The doomsday metal reached a record nominal price of $1,497 for May delivery. (The inflation-adjusted price peaked in 1980.) That was a gain of 0.7%. Corn, however, jumped 1.3%. Wheat gained 4.3%. Weather forecasts called for a continuation of dry wheat-growing conditions in the U.S., Europe and China, making it difficult to determine what portion of the gains was owed to rising investor demand for safe-haven assets.
Takeaway: Gold fans might want to diversify with grains. Those not put off by comically long fund names may consider the iPath Dow Jones-UBS Grains Subindex Total Return exchange-traded fund (JJG)
Surprise 3: The dollar gained on rivals.
The U.S. dollar index, which tracks the buck's value relative to six rich-world currencies including the euro, British pound and yen, rose nearly 1% Monday. Investors continue to view the dollar as the least-dangerous place to hide in a crunch, or perhaps they view S&P's Treasury outlook downgrade and the fiscal cleanup it might force as hope that the U.S. Treasury won't have to endlessly print dollars to pay the nation's debt. Or, investors might just see a bargain. Currency values aren't abstract numbers, after all; they decide the purchasing power of citizens. The Economist's not-quite-serious Big Mac index, which uses world burger prices to determine which currencies are under- or over-valued, suggests the euro is nearly one-third too pricey relative to the dollar. Purchasing power data from the Organization for Economic Cooperation and Development, based on a broader basket of goods, agree.
Takeaway: The doomed-dollar trade into other currencies looks overdone.
Surprise 4: International stock diversification didn't (seem to) help.
The S&P 500 index finished well off its low Monday, down 1.1%. European markets closed before the late-day rebound in New York, leaving most of them with larger losses, but Latin America also fared poorly. Brazil lost 2%.
Takeaway: None. Stock investors who diversify among world markets shouldn't use short-term declines as a test of whether their strategy is working. In a March 2010 paper, hedge fund manager Clifford Asness and others used stock returns and exchange rates for 22 countries to show that diversification does little to protect investors during a short-term crash, but does plenty to protect them from a larger risk -- a prolonged economic slump in one or more of the countries in which they invest.