Bizarro World: Stocks Rally on Bad News From Moody's About Banks

In the Age of the Downgrade, investors have grown accustomed to bad news.

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At first, it sounded like a real bummer for the markets.

Ratings agency Moody's recently downgraded its credit ratings on 15 of the world's biggest banks, a sign of the ongoing stress in financial markets. Five American banks—Citigroup, Bank of America, Morgan Stanley, J.P. Morgan Chase and even the impregnable Goldman Sachs—got dinged.

The news sent stocks … higher.

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If you're wondering why, keep in mind that investors have become inveterate worrywarts prepared for the sky to fall. There's so much bad news out of Europe that they're prepared for a repeat of the 2008 financial meltdown. Washington isn't helping, as it staggers toward a "fiscal cliff" characterized by year-end tax hikes and spending cuts.

Moody's had warned way back in February that it was reviewing the creditworthiness of about 100 big banks and might issue downgrades. That gave investors four months to imagine the worst. When the downgrades finally came, they weren't as bad expected. Analysts had worried that Morgan Stanley, for instance, would get downgraded by three notches, but Moody's only cut its rating by two. "There is a measure of relief that the downgrades by Moody's for some firms were not as severe as expected," Patrick O'Hare of Briefing Research explained to clients.

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Meanwhile, the stocks of all five downgraded U.S. banks rose following the announcement, lifting the overall market higher (at least until the next spate of gloomy news hits).

The bipolar response to the bank downgrades reflects the dulled impact of changes in rating-agency opinions. The three big credit raters—Moody's, Standard & Poor's, and Fitch—suffered their own reputational downgrade during the housing bust that precipitated the 2008 meltdown, by giving their top ratings to hundreds mortgage-related securities that ended up being "toxic waste" stuffed with subprime mortgages destined to default. As a result, the agencies have become much more circumspect about their ratings and more deliberate about telegraphing what's coming, so investors aren't blindsided.

The ultimate downgrade was the move by Standard & Poor's last summer to drop the U.S. credit rating by one notch, the first time that had ever happened. Many people considered that a disaster that would raise borrowing costs for the Treasury Dept. and mark the end of easy money for Uncle Sam. But the opposite happened. On the day of last year's downgrade, the interest rate on benchmark 10-year Treasury bonds was 2.58 percent. Since then, it has drifted down to 1.65 percent.

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The broader takeaway may be that we're in the Age of the Downgrade, with many assets more suspect and less valuable than they seemed a few years ago. It's no longer surprising to hear that a government or company or investment isn't as trustworthy as it used to be. The best news, in fact, may come when the worst-case scenario doesn't pan out. These days, a modest downgrade might even be a mark of stature.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.