Before we get to today’s issue, I wanted to alert readers to something…
Tomorrow morning, two colleagues of mine, Whitney Tilson and Jeff Brown, will be hosting a special presentation. For readers that don’t know, Whitney is a former hedge fund manager and current editor of Stansberry’s Investment Advisory. And like us, Whitney has a value-centric approach to investing.
As for Jeff, what I admire about him is that he, like myself, came from the industry he covers. I spent years as a commercial real estate developer. That experience provided a unique insight into the real estate investment trust market ever since. Similarly, prior to publishing research on technology markets, Jeff worked as a tech executive in the U.S. and Japan. And that has made him one of my go-to sources for all things tech.
Whitney and Jeff believe a consequential day is coming for markets – June 2. During the presentation, they’ll reveal their prediction, including what investors should do ahead of that date. Jeff will also give details on a little-known tech company he believes could be “Nvidia’s most worthy competitor.”
If that sounds of interest, you can get all the details right here.
Just remember, they go live tomorrow at 10 a.m. EST. So, be sure to reserve your seat before then.
Now, let’s turn to today’s issue.
By now, you’ve probably seen the news. Moody’s took the U.S. down a literal notch from an Aaa credit rating to Aa1. The S&P 500 had a kneejerk sell-off at the open yesterday. But as I write to you, we’re essentially back to Friday’s closing level.
The agency’s rationale was that American debt and interest payment ratios had run amok for “more than a decade.” And President Donald J. Trump was just going to make it worse.
To quote Moody’s directly:
If the 2017 Tax Cuts and Jobs Act is extended, which is our base case, it will add around $4 trillion to the federal fiscal primary (excluding interest payments) deficit over the next decade.
As a result, we expect federal deficits to widen, reaching nearly 9% of GDP by 2035, up from 6.4% in 2024, driven mainly by increased interest payments on debt, rising entitlement spending and relatively low revenue generation. We anticipate that the federal debt burden will rise to about 134% of GDP by 2035, compared to 98% in 2024.
Of course, Trump’s “Big, Beautiful Bill” that would extend those tax cuts hasn’t passed yet, despite recent forward movement. So, Moody’s might be trying to put political pressure on elected officials to vote against it.
Then again, it might simply be following mainstream thinking. But considering how it issued the downgrade regardless, we’re left with two questions…
Could the U.S. ever really default on its debt? And what should we as investors do about the downgrade?
I’ll spare you the suspense. My answers, in order, are:
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It’s exceedingly unlikely
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I wouldn’t worry about it too much
Can the U.S. Actually Default?
I understand why the news spooked the market. U.S. Treasurys are the cornerstone of the financial system. They’re the gold-standard of safe haven assets, the measuring stick that all other assets are measured against. Any change in the perceived credit worthiness of the government issuing those bonds is news.
But first, it’s worth remembering that, even with the downgrade, the current rating from Moody’s is still solidly in investment-grade territory. I’d have no qualms about investing in a public company with an Aa1 rating. That’s a fortress balance sheet.
And if you’re worried about a literal default, I really wouldn’t.
The U.S. debt market is the largest and most liquid in the world. And there’s really no substitute for it.
The German Bund, which serves as a benchmark for eurozone bonds, is a fraction of the size. China’s debt market is closer in size, but that country hasn’t been forthright in releasing economic data, as The Wall Street Journal reported recently. That doesn’t strike me as a replacement either.
That leads me to believe there will continue to be plenty of demand for U.S. debt for the foreseeable future. And a government with plenty of demand for its debt isn’t one that usually defaults.
If I had to categorize the possibility of the U.S. default, I’d say it’s technically possible… but exceedingly unlikely. It’s certainly not the sort of thing that should keep you up at night.
I also think Moody’s overlooked a key element of the Trump administration’s economic goals…
It’s Always Growth
Before Donald Trump was president, he was a real estate developer. He understands that growing the value of your assets is a quick way to become under levered. His purchase of Mar a Lago is an interesting example.
He financed the $10 million purchase of the property in 1985. That sounds like a lot of debt, especially in the 1980s. But after the purchase, he turned the property into a private club where members would pay regular dues. And as you might imagine, those fees started to add up, especially when he became president. I’ve seen reports that Mar a Lago produces approximately $20 million in yearly revenue now. Combine this with the growth in the property value, and that original $10 million in debt is nothing.
That might seem like a simple example, but it holds true for countries, too. Debt isn’t necessarily a problem if it can result in more growth. I believe that’s the Trump administration’s plan.
Contrary to what you might read, the U.S. is racking up economic wins right now. I wrote about this last Thursday: that “in case you were tempted to bet against America, don’t. Our Golden Age has officially begun.”
For proof of that, just look at the ever-expanding number of companies committing enormous amounts of money to the U.S. The list includes:
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$500 billion from Apple (APPL)
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$500 billion from Nvidia (NVDA)
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$500 billion from Softbank, OpenAI, and Oracle (ORCL) combined
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$150 billion from IBM (IBM)
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$100 billion from Taiwan Semiconductor Manufacturing Company (TSM)
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$55 billion from Johnson & Johnson (JNJ)
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$50 billion from Roche
And those are only the largest corporate announcements made so far. Added up with all the smaller examples, the White House lists over $2 trillion of such investments – complete with links – to say nothing about the deals Trump just secured with Saudi Arabia, the United Arab Emirates, and Qatar.
Then there’s the $160 billion the Department of Government Efficiency has cut from the federal budget. There have been plenty of hit pieces about how this is far short of the “at least $2 trillion” Elon Musk vowed to eliminate. But keep in mind that we’re only four months into Musk’s official role in this regard.
There’s much more room to run here, both in cuts and investments.
White House Director of Communications Steven Cheung’s attributed the credit ratings downgrade to Moody’s Analytics Chief Economist Mark Zandi being “an Obama advisor and Clinton donor who has been a ‘Never Trumper’ since 2016.” And White House Spokesman Kush Desai added that, “If Moody’s had any credibility, they would not have stayed silent as the fiscal disaster of the past four years unfolded.”
But even if they’re wrong in that dismissive analysis, there’s another reason to think this credit rating cut ultimately means nothing.
The Historical Case to Keep Disregarding the Downgrade
As I said before, there are very good historical reasons to shrug off Moody’s downgrade.
As Jim Cramer of CNBC’s Mad Money fame tweeted yesterday morning, “The market dropped 6.7% after the last downgrade back in 2011. But it ultimately meant nothing; and while the market kept falling for weeks, you had to stay the course.”
Say what you want about Cramer, but he’s not wrong this time.
When Standard & Poor’s made history in 2011 by being the first agency to ever downgrade U.S. debt, the S&P 500 plummeted over the next 41 trading days. And when Fitch did the same in August 2023, that index slid over 58 days.
Yet 12 months after those market-roiling announcements, stocks were up 36% and 37%, respectively.
So investors who stayed steady throughout the turmoil made out very nicely in the end. And those who bought quality stocks at the resulting discounts did even better.
Unfortunately for discount shoppers like myself, however, we might not find any such opportunity this time around. Investors seem to be glossing over Moody’s move altogether.
That might be because nothing really changed after the last two downgrades. Or they might buy into the possibility that this downgrade was political rather than professional.
One way or the other though, I remain convinced about what I wrote last Thursday. It’s hard to take a one-notch downgrade too seriously after the:
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May inflation report
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Better-than-expected jobs reports
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U.K. trade deal
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All those corporate and international investments that keep piling in…
While anything can still happen from here, my bottom-line analysis remains the same: I still see plenty of winning ahead.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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