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Home Publications Blogs Beat the Press If a Negative S&P Outlook for the U.S. Explains a Drop in Stock Prices, Why Did the Dollar Rise and Interest Rates Fall

If a Negative S&P Outlook for the U.S. Explains a Drop in Stock Prices, Why Did the Dollar Rise and Interest Rates Fall

Monday, 18 April 2011 09:23

Reporters should be given 40 lashes when they tell us that some specific event explains a movement in stock prices. The reality is that the reporter does not know what caused a movement in stock prices, all they can do is speculate.

This means that the beginning of a NYT piece on the drop in stock prices Monday morning that began:

"shares on Wall Street opened sharply lower and Treasury prices fell on Monday after the Standard & Poor’s rating firm lowered the outlook for the United States to negative, saying that there was a risk that lawmakers might not reach agreement on how to address the country’s fiscal issues,"

is pure speculation. The NYT does not know why stock prices fall.

Its explanation seems inconsistent with two other market movements this morning. The dollar rose sharply against the euro and other major currencies. Also, the yield on 10-year Treasury bonds fell by almost 4 basis points.

It is a bit hard to believe that investors sold off U.S. stocks because they became fearful in the wake of the S&P report, but then suddenly wanted to buy dollars and also were willing to hold Treasury bonds at a lower yield. Unless we think that investors in stock are a totally distinct group from the people who trade currencies and invest in bonds, the NYT's explanation of the plunge in stock prices makes no sense. 

A more plausible explanation is that bad earnings reports, most importantly from Bank of America on Friday and from Citigroup on Monday, made investors more pessimistic about the near-term prospect for profits.

It is also worth noting that S&P has a horrible track record for judging credit worthiness. It rated hundreds of billions of dollars of subprime backed securities as investment grade. It also gave Lehman, Bear Stearns, and Enron top ratings right up until their collapse. Furthermore, no one was publicly fired for these extraordinary failures. Investors are aware that S&P's judgement does not mean very much.

Comments (8)Add Comment
written by kharris, April 18, 2011 11:17
Um, no. Not this time. Asking for a conventional stocks-up-so-bonds-down trade as a sign that there is a single brand of thinking going on involves two errors. One is that, for brief periods of time, their need not be a single brand of thinking. If markets reached equilibrium instantaneously and all portfolios contained more or less a complete set of available financial assets, then we might expect the stocks-up-so-bonds-down trade, as long as the news driving the trade does not have negative implications for both. In the case of a new risk of higher average borrowing rates and scarcer capital, on average, stocks and Treasuries would both fall. Trouble with the dollar? Look at short-end rates. Everything from 5s in jumped, while everything longer than 5s fell. Ratings downgrades don't happen right away.

A useful way to think of all these things is in terms of specific risks, not just "risk" as a bugbear for investors. The specific risk raised by S&P has to do with higher US borrowing costs, relative to what otherwise would have been the case, some time down the road. Not now. While the implications are being sorted out, bills and the dollar look pretty good.

Speculation? Sure, though not entirely. But there is a bit of speculation behind the criticism you (Dean) offer, too. Your speculation is that this day's shift is of a certain type, one in which Treasuries go down when stocks go up, or vice versa. That is not today's trade, at all.

Oh, and the timing lines up pretty well. The European news was already out some hours earlier. Then, no release of the S&P view, prices moved sharply. It is not credible to blame Europe for the drop in stocks, when the drop in stocks happened on the release of US ratings news.
Speculation on Stock Prices
written by Dean, April 18, 2011 1:00

I intended my comment to be speculation. No one tells me the true factor that is moving stock prices.
Stocks fell after bjk's morning breakfast.
written by bjk, April 18, 2011 5:31
True and not speculative.
written by BL, April 18, 2011 6:27
Dean, from a semantic point of view, the NYT is not actually stating that stocks fell because of the S&P's lowered outlook. The literal meaning is that one thing occurred after another, which is true. Of course, all business reporting in the NYT and elsewhere use this construction to report imply a causal relationship. My favorite example is of the same business publication writing, in the same week, that stocks rose after a rise in the price of oil futures, and then claiming that oil futures continued to rise, dragging stocks lower.
Buying dollars?
written by user432, April 19, 2011 12:24
Are you buying dollars when you sell your stock holdings?

Wouldn't that explain the rise in the dollar?
Calm Down Dean
written by J-Bentham, April 19, 2011 12:33
Calm down.
Dollar rises SHARPLY
written by Philip Pilkington, April 19, 2011 8:31
Are you buying dollars when you sell your stock holdings?

Wouldn't that explain the rise in the dollar?

I don't think that would account for a 'sharp' rise in the dollar vis-a-vis the Euro. I think it would be more plausible to look at all the talk of a Greek default in the Eurozone at the moment -- by my reading, that's the big issue buzzing around the financial commentariat at the moment.

That might also go some way to explain the fall in Treasury yields -- which your explanation can't account for.

I qualify this, of course -- I don't know any of this as a fact.
vibram five fingers
written by vibrams five fingers, April 20, 2011 4:50

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.