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

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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.