The recent debt downgrade by Fitch rating service has caused significant concern in the market. However, looking back at the 2011 debt downgrade, it is clear that the initial reaction to such events may not always reflect the long-term impact on the market. In fact, the current technical backdrop of the S&P 500 (SPX) is much stronger than it was in 2011. This article will explore the lessons learned from the 2011 debt downgrade and provide an analysis of the current market outlook.
1. The 2011 Debt Downgrade: Lessons Learned and Current Outlook
The 2011 debt downgrade caused a sharp decline in the market initially, but the downside risk was limited in the following months. The current debt downgrade by Fitch has resulted in a steady decline in the SPX since August 1st. However, it is important to note that the SPX remains above its 40-day moving average and double the 2020 closing low. This suggests that there is a stronger technical backdrop in the market now compared to 2011.
2. Assessing Risk in the Financial Sector After Recent Downgrades
Another factor to consider is the impact of the recent credit downgrade of ten financial companies. This downgrade has led market participants to assess the risk in the financial sector and the broader economy. It is crucial to monitor the Cboe Market Volatility Index (VIX), which has been rising from its pre-Covid lows. The recent peak in the VIX, which was half of last year’s closing high, could indicate that this could be the worst of the speed bumps in the months ahead. However, caution should still be exercised if the VIX moves above this level in the future.
3. Analyzing the VIX: Is the Worst of the Market Turmoil Over?
The VIX provides valuable insights into market sentiment and volatility. Last week, the VIX peaked at a level that was half of last year’s closing high. This could suggest that the market turmoil may be nearing its end. However, if the VIX continues to rise, it could have bearish implications for the market. Investors should keep a close eye on the VIX to gauge the level of risk in the market.
4. SPX Technical Analysis: The Impact of Recent Downgrades
The recent downtrend in the SPX has raised concerns about its technical outlook. The SPX closed below potential support levels, including double its March 2020 closing low and its 40-day moving average. However, it managed to stay above the 50-day moving average, indicating potential support. It is crucial for the SPX to regain its 40-day moving average and key support levels to confirm that Friday’s low could be a major trough. Monitoring the 20-day moving average, which is currently declining, can also provide additional insights into the market’s direction.
5. Sentiment Shift: Money on the Sidelines and the Potential for a Market Trough
The sentiment in the market has shifted as optimism has been wrung out. The options market reflects this sentiment shift, with the 10-day buy (to open) put-call volume ratio on SPX components reaching its highest level since mid-May. Active investment managers have also retreated from the market, reducing their allocation to stocks. This suggests that there is money on the sidelines, which could be invested at or near the support levels discussed earlier. However, a shift in sentiment is necessary for a market trough to occur.
In conclusion,the recent debt downgrade and credit downgrade have raised concerns in the market. However, the lessons learned from the 2011 debt downgrade indicate that the initial reaction may not be indicative of the long-term impact on the market. The technical backdrop of the SPX is stronger now compared to 2011, which provides some support for the market. Monitoring the VIX, SPX technical levels, and sentiment indicators can provide valuable insights into the market’s direction. While there are risks to consider, such as a potential shift in sentiment, there may be more reward than risk in the weeks ahead. Investors should remain cautious and closely monitor market developments to make informed investment decisions.
Analyst comment
As an analyst, I believe that the market may experience some short-term volatility due to the recent debt downgrade by Fitch rating service and credit downgrade of financial companies. However, the lessons learned from the 2011 debt downgrade suggest that the long-term impact may be limited. The technical backdrop of the S&P 500 is stronger now compared to 2011, which provides some support for the market. Investors should monitor the VIX, SPX technical levels, and sentiment indicators to gauge the market’s direction. While there are risks to consider, there may be more reward than risk in the weeks ahead.
