BOSTON Time to brace for leaner times in America.
Underneath all the angst over Standard & Poor's warning to downgrade the United States' AAA credit rating within two years, investors say the most important message is that austerity is around the corner.
And that means investors are looking to invest in so-called defensive stocks that can grow revenue even in bad times. Treasury bonds and non-U.S. bonds including emerging market securities rather than companies that rely heavily on a robust economy and low interest rates.
By coming out with its announcement now, S&P has put pressure on President Obama's Democratic administration and Republican lawmakers to slash the U.S. budget deficit in the next few years.
However that is done -- whether through spending cuts favored by Republicans or whether through a combination of spending cuts and tax increases favored by Democrats -- it threatens to create a big headwind for economic growth.
S&P's warning, which cited a risk that policymakers may not reach agreement on a plan to slash the huge federal budget deficit, is "good for Treasuries and bad for the economy and stocks," said DoubleLine Chief Executive Officer Jeffrey Gundlach, because the U.S. economy will "soften substantially" with less stimulus.
Just last week, many economists were already ratcheting down their growth estimates, forecasting Gross Domestic Product as slow as 1.4 percent in the first quarter, less than half the 3.1 percent logged in the final three months of 2010. A slew of recent data releases lie behind the sharp cuts, including reports last week on retail sales, business inventories and trade.
While first quarter GDP could be short-term, "fiscal tightening means the outlook for growth is less bright than it was before the S&P announcement," said Mohamed El-Erian, the co-chief investment officer of PIMCO, which oversees $1.2 trillion in assets.
Wall Street fell more than 1 percent on Monday as Standard & Poor's downgraded its credit outlook for the United States to "negative" from stable.
But in a sign of what might come next, the pain was spread unevenly. Economically sensitive companies like Alcoa and Caterpillar slid between 2 percent and 3 percent. Dividend-paying stalwarts with reliable income streams, like Kraft and Microsoft, eased 1 percent or less.
"The defensive categories are faring slightly better than the cyclicals today," David Joy, chief market strategist at Columbia Management, said.
Among exchange-traded funds, the Consumer Staples Select Sector SPDR was off just 0.55 percent on the New York Stock Exchange, while the Consumer Discretionary SPDR was off 0.89 percent, for example. The Utilities SPDR was off 0.87 percent while the Materials SPDR dropped 1.32 percent.
INVESTING ON DOLLAR WEAKNESS
For his part, Gundlach of DoubleLine argues that Treasuries will become increasingly attractive and yields will go lower as the U.S. growth slows in the months to come.
Long-term Treasuries have been under selling pressure for months even as the Federal Reserve has carried out $600 billion in purchases in a second round of quantitative easing to boost the economy. The policy, known as QE2, has been negative for bonds, Gundlach says, "because QE2 is an inflationary policy."
While bonds are seen gaining from budget cuts, the dollar is likely to come under pressure. The budget battle ahead, as well as a weakening economy could hit the currency, fund managers said. The S&P warning was a fresh reminder that investors need to prepare.
"As we continually experience these periodic crises, investors around the world will lose faith in the dollar as the risk-free currency," said Aaron Gurwitz, chief investment officer at Barclays Wealth in New York. "We're using this as an opportunity to remind people about the percentage of their portfolio that is denominated in U.S. dollars."
Investors should be increasing their allocations to non-U.S. bonds, particularly local currency emerging market debt, non-U.S. real estate and commodities, Gurwitz said.
Money manager Roger Nusbaum at Your Source Financial in Phoenix is spreading client assets across a wider array of non-U.S. bonds, including sovereign debt from Australia, Denmark, New Zealand, Norway and Canada as well as the PowerShares Emerging Market Sovereign Debt Fund.
Jeffrey Sica, president of SICA Wealth Management in Morristown, New Jersey, is even more bearish. Sica is slashing U.S. equities holdings of his clients in favor of cash, precious metals and commodities. He favors exchange-traded funds like the ETFs Gold Trust and the PowerShares DB Agriculture Fund.
"This just creates a lot of uncertainty and insecurity that will affect any markets that were vulnerable to begin with and that includes U.S. stocks and bonds," Sica said.
(Reporting by Aaron Pressman in Boston, with Jennifer Ablan and Herb Lash in New York)(Editing by Richard Satran and Chelsea Emery)