Wall Street shares fall sharply on S&P cut to US debt outlook

Source: Brendan Conway,Dow Jones Newswires April 19, 2011 - theaustralian.com.au

US stocks suffered a rout after Standard & Poor's cut its outlook on the US government debt, warning that the US fiscal profile may become "meaningfully weaker" than that of other triple-A-rated countries if policymakers can't tame the budget deficit.

The Dow Jones Industrial Average fell 140.24 points, or 1.14 per cent, to 12,201.59, led lower by Bank of America and Caterpillar, which each fell 3.1 per cent.

The S&P 500index dropped 1.1 per cent to 1305.13, with energy and industrials stocks taking the hardest hit.

At session lows, both measures staged their biggest drop in a month.

The Nasdaq Composite fell 1.1 per cent to 2735.38.

The ratings firm cut its outlook on US government debt to "negative" from "stable," to account for budget deficits and rising government indebtedness.

"We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013," credit analyst Nikola Swann wrote.

The Treasury Department issued a statement contending that S&P's negative outlook "underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation".

Sandy Lincoln, chief investment strategist at M&I Investment Management, said the revision was a "shot over the bow" in Washington that could aid markets if it helps politicians overcome political disagreements on handling the debt.

"This says, 'Please get your act together and find some way to a consensus viewpoint,'" he said.

The dimmer debt outlook overshadowed corporate earnings just as reporting season was getting into high gear.

Earnings season has been "just good enough to keep mark participants guessing," but not good or bad enough to push the stockmarket measurably in one direction or another, said Mark T. Lamkin, chief executive of Lamkin Wealth Management.

Citigroup finished flat at $US4.42 after the bank posted better-than-expected first-quarter earnings and showed signs of improving credit quality, though revenue fell shy of forecasts.

Halliburton gained 0.7 per cent after the oil-field service company's first-quarter profit more than doubled. Chief executive David Lesar said there was "clearly room for revenue and operating incomes to grow" in 2011.

In the bond markets, long-dated Treasuries clawed their way into gains after enduring a sharp sell-off sparked by S&P’s "negative" outlook on US credit that sent investors fleeing to shorter maturities.

Although the flight to safety calmed by mid-session, longer-dated securities underperformed as the ratings agency's action aggravated fears that US leaders might be unable to agree on a plan to reduce the country's growing debt burden.

"There was a lot of confusion, and people really weren't prepared for this (negative outlook)," said Rich Tang, head of fixed-income sales at RBS Global Banking and Markets, adding that overall volume "is not as heavy as one might think" since investors struggled to position for the unexpected news.

Still, investors' immediate reaction to S&P's demotion of US sovereign credit sent yields on benchmark Treasuries as high as 3.451 per cent.

Richard Gilhooly of TD Securities said investors were seen selling longer-dated notes and buying the short end after the S&P announcement. Notes with longer maturities are more sensitive to changes in a sovereign issuer's perceived creditworthiness.

Instead, shorter-dated notes benefited from the safe-haven buying prompted by renewed credit concerns in the euro zone over the weekend, and enjoyed further support as the long-end sold off, traders said.

S&P's negative outlook highlights the escalating debate over how to reduce the mounting US debt. The government narrowly avoided a shutdown recently, with a last-minute federal funding deal that still left the debt ceiling issue up in the air.

The Treasury has said the US is expected to exceed its current $US14.3 trillion ($13.6 trillion) limit by mid-May, and could default on its debt in early July if no action is taken by Congress to raise the debt ceiling.

Uncertainty about US debt has weighed on Treasuries in past weeks, underscored by bond guru Bill Gross, who said he saw "little value" in US government bonds given the nation's ever-increasing debt burden.

In February, Mr Gross, who is chief investment officer of the world's biggest bond fund at Pacific Investment Management Co, dumped all Treasury holdings from the Total Return Fund.

Based on S&P's explanation, however, the threat of an actual ratings downgrade isn't seen as coming for another two years.

That is an unusually lengthy outlook, CRT Capital Group's David Ader noted, which suggests the motivation behind S&P's move "as a bit of prodding to get the government going".