Monday, August 1, 2011
Stocks will likely reverse some of last week’s losses as the overnight debt deal in Washington removes a key source of uncertainty from the market. The deal removes the threat of a default, though the threat of a rating downgrade still remains.
The deal raises the debt ceiling and provides for deficit reduction measures totaling $2.4 trillion through a two-stage process. The first stage provides for $900 billion in deficit reduction over 10 years. In the second stage, a special congressional committee identifies an additional $1.5 trillion in deficit-reduction measures over 10 years. But if the committee is unable to find those cuts, then automatic spending cuts totaling $1.2 trillion will kick in.
While a lot of details about the deficit reduction measures remain unclear at this stage, the deal takes the prospect of a default off the table. It does not, however, remove the threat of a rating downgrade. The rating agencies had been threatening in the run up to this deal that they needed to see much bigger deficit cuts than this deal provides for. It will be interesting to see how the rating agencies respond to the deal. But the market did not appear to be overly concerned about the prospect of a rating downgrade.
With the noisy debt debate now behind us, the lack of growth momentum is the U.S. economy will take center stage. We knew all along that the economy was going through a soft patch, but we found Friday morning that we hardly had any growth. The serious negative revisions to the growth rates in the preceding quarters puts a question mark on the growth expectations for the second half of the year, which have held up fairly well thus far.
And if growth expectations for the second half of the year start coming down, then questions about earnings expectations are bound to be raised as well. Corporate earnings remained largely unaffected by the U.S. economy’s weak run in the first half of the year.
We have seen solid earnings results thus far in the second-quarter reporting season currently underway. But it would not be unreasonable to to question the sustainability of earnings growth in the coming quarters should the first half softness extend into the back half, as well.
But those are questions for the coming days. The market’s focus today will be on the debt deal. Relief at the end of the default threat trumps concerns about ratings downgrades and economic growth, at least for today.
Sheraz Mian
Director of Research
Zacks Investment Research
