On May 16th, Moody’s became the last of the three major credit ratings agencies to downgrade US long-term issuer ratings from Aaa to Aa1 and changed the outlook to stable from negative. Their rationale was the rise in sovereign debt.
Investors focused on news and headlines might have expected both debt and equity markets to have a very negative reaction to this development. What we got instead was a collective yawn. Credit default swap (CDS) spreads barely budged during the period surrounding the downgrade. Why? Perhaps the CDS level remained roughly the same because the market didn’t learn anything new. Remember, the rising US debt level is hardly breaking news.
This example brings us to the main point: both debt and equity markets are remarkably efficient processors of information. It is frequently tempting to view headlines, develop an investment thesis based on those headlines and then go execute trades based on that thesis. Unfortunately, it isn’t that easy. Long-term study after long-term study has shown that far more often than not, this approach to investing leads to return that trail the market, frequently by large amounts.
Since our founding, Claris has advised clients to ignore the headlines and build an investment policy based on their willingness, ability and need to take risk. Once this policy is designed, we work with clients to help ensure they stay the course through good times and bad. Evidence has shown this is the most reliable way to enjoy a fruitful, long-term investment experience.
