About that Downgrade

After the close on Friday the S & P folks downgraded US debt, here.  The ramifications of this are hard to understand but I offer one view of it.

Back in the day when I was studying for the CFP (Certified Financial Planner) the mantra was that people invest in stocks because they provide an acceptable risk/reward rate of return above treasuries.  If you are not willing to accept any risk then put your money into treasuries.  We had to know the formulas for estimating future prices of stocks and one common formula used the basic idea known as the risk free choice, using US treasury bonds of some duration, often the 10 year.  The formula used the current stock price, the current treasury yield, a future date in time, projected earnings per share, and did a time value of money calculation.  So the estimated future price of a stock would be based on some acceptable level of risk above the rate of treasuries.

Now that treasuries have been downgraded, they cannot be viewed as risk free and some other AAA rated instrument should be used.  What it will be, I do not know.

Thus, estimating future returns of stocks is now made more difficult.  Thus, more uncertainty will hit the markets.

Another thought is that all the contracts and loans that require AAA bonds as collateral will now be in jeopardy because that collateral is likely treasuries.  Some bank borrows 100 million and puts down 10 million in treasuries as AAA collateral now has to dump their treasuries and swap in something else.

All this suggests that precious metals will bounce hard.  Maybe that is why they were smacked down last week as the insiders played this game.