Standard & Poor's downgrade of the US to AA+ may be a landmark event, and yet almost every major country (with some dissent from China) has come out with statements in support of the US dollar and US Treasuries.
“Given the market reaction after the downgrade with equities down and Treasuries up, one could be forgiven for thinking that S&P downgraded the stock market of the US and not its credit rating,” says Sanjiv Garg, lead portfolio manager at Winnington Capital in Hong Kong.
“In reality, there is very little difference between AAA and AA+ and the little sliver that separates them isn't going to affect earnings growth or tip the entire country into a recession. So, it is fear and not reason that is driving the market reaction.”
What, though, of the current volatility (at the time of writing mostly one way – downwards). Is it going to persist, or is volatility a temporary phenomenon?
“Our view is that it will subside. We think buy Asian equities, short Western government bonds is the stand-out trade. For the next five years it's the only trade you need to have on,” says Steve Diggle of Vulpes Investments in Singapore.
The volatility may abate, but what is still unpredictable is what detritus is going to be left behind, as the world may not be the same place as before the US had its crown knocked off.
Eddie Tam, CIO of CAI Global Fund in Hong Kong, says: “In the medium-to-long term, we're still very concerned about the potential knock-on effect on all dollar-denominated instruments such as agencies, munis, corporate bonds (both investment grade and junk), as well as equities.
"In particular, Hong Kong equities as well as other assets could be very vulnerable, due to the HK dollar peg to the US dollar. If the US dollar does actually weaken significantly more, then inflation could worsen and the cry for a break of the peg will get louder.”
With markets falling so fast, disciplined hedge fund managers are going to be obliged to add to the momentum by cutting positions that have fallen below stop-loss limits. A lot of managers have gone into this summer net long.
At the Morgan Stanley hedge fund managers conference in Beijing this May, a panel of hedge fund managers voiced caution and bearishness at the same time as saying that they were about 70% net long. The hedge fund manager sitting next to this reporter whispered. "They say they're so cautious yet they're still so net long. Our net exposure is a hell of a lot less than that."
The retail-dominated Shanghai A-share market was flat on Tuesday, on volumes that were 20% higher than on each of the last 30 trading days.
“China’s balance sheet looks stronger versus Europe’s and the USA’s, and people are looking for assets that they can own and regard as a safe haven,” says Aaron Boesky, CEO of Marco Polo Pure China Fund in Hong Kong. “With ‘Problem USA’ and ‘Problem Europe’ hitting the headlines, China’s omission from that list makes it a ‘Perfect Storm’ for them in a positive way. I think China is relieved that this particular crisis isn’t theirs.”
Still, what do American born n' bred fund managers feel about their Washington overdogs? One expressed a tinge of regret for his nation that many may be feeling.
“What is left for one to say? As an American voter and taxpayer, I am thoroughly disgusted,” says Paul Sheehan, CEO of Thaddeus Capital in Hong Kong. “The United States, pushed by a minority of crazed economic illiterates came within hours of voluntarily defaulting on its debt, an act of almost suicidal stupidity.
"As the result of this brinksmanship, we have finally achieved a breakthrough bipartisan agreement on – absolutely nothing as far as I can see. The deficit will remain huge, the debt burden will grow, and that's if we assume like naïve children that all of the significant spending cuts in this agreement – the ones conveniently set to kick in after the next election – will actually happen as promised.
"The American government is morally and intellectually bankrupt, and is proceeding on its merry way to being literally bankrupt.”