Commentary on the S&P downgrade and the current situation

We still recommend that readers go back and read the previous two posts discussing the latest market volatility and widespread fear of impending recession that has been rising over the past couple weeks and escalated sharply at the end of last week.

Those two posts were published before the S&P downgrade of the US Treasury's credit rating on Friday afternoon. For some perspective on this latest development and how it fits into the larger picture, check out the video above of Gerry Frigon speaking on KCOY television this morning.

We would also recommend the perspective of economists Scott Grannis (see his post from yesterday here) and Brian Wesbury (see his essay from this morning here).

It is also noteworthy that the US Treasury prices are actually going up rather than down in the first day of trading after the S&P downgrade. This fact may be evidence that the downgrade has more political significance than economic significance. However, it is also important to note that this downgrade forces large institutional investors to sell other forms of debt that they own for their investors and to purchase more Treasurys. This perverse consequence is the result of the "law of unintended consequences" explained two weeks ago in a different post by economist Scott Grannis.

We have previously highlighted other instances of consequences that well-meaning politicians often create when they write legislation that attempts to restrict the free decisions of rational actors and tells them what they are allowed to do with their own money (how much they should be allowed to pay employees, for instance, or what kinds of bonds they should be allowed to buy). For discussions of that subject, see here and here.

Also highly recommended is the editorial from the opinion-page editors of the Wall Street Journal this morning. They point out that the rating agencies only care about balance, and have no opinion over how to make it happen. The debate about how to reduce the imbalance has been raging for some time now and intensified over the weekend.

Increasing revenues and lowering spending are obviously the two components of a solution, but some politicians continue to believe that increasing revenues is best done by raising tax rates. We believe that such an idea couldn't be further from the truth: the best way to raise revenues, as the WSJ piece points out and as we have argued many times in this blog, is to unleash innovation and growth. Increased tax rates squash innovation and growth. For a few previous posts with evidence to support this fact, see here, here, and here.

We believe that the most important thing for investors to do in times like these is to remain disciplined, and to focus on the fundamentals of the individual companies to which they are providing investment capital.