Faber On U.S. Downgrade: U.S. To Have "Some Kind of Default", But Market "Incredibly Oversold"

By EconMatters

Markets saw its worst day since the 2008 financial crisis on Monday, Aug. 8, the first trading day since Standard and Poor's downgraded the United States' credit rating. Under the weight of a possible twin crisis in Europe and in the U.S., Dow Jones industrial plunged 634 points. Stocks have lost 15% of their value in just two and a half weeks.

On a day like this, who else other than Marc Faber, publisher of the Gloom, Boom & Doom report, would be more appropriate to appear on Bloomberg to talk about the aftermath of the U.S. debt downgrade. Below are some of the highlights in the Bloomberg interview. Regarding equities, Faber believes the U.S. market is "incredibly oversold" and could bottom out in the next few days, but the rally will unlikely make new highs this year.

Faber indicates a bear market already started on May 2, 2011 when S&P reached 1,370. The downgrade on U.S. debt by S&P is actually moderately positive on equities as it showed investors that in addition to the conventional interest rate risk factor, now there's another risk--sovereign credit downgrade--in government bonds anywhere in the world. So in the next 10 years, investors will be better off in equities, precious metals than in bonds.

Concerning the downgrade by S&P, Faber goes beyond and says 'some kind of default" will happen for the U.S. as the country's "fiscal position is a disaster" if you include the unfunded liability. There are two ways a government can default:

1. Default by not paying the interest and restructuring its debt as happened in Argentina and other countries repeatedly.
2. Repay debt and interest in a depreciating currency, and U.S. dollar is losing more value and purchasing power than other currencies.

On the possibility of another round of quantitative easing (QE3), Faber sees QE3 would take place when the economy shows significant weakness, or S&P index falls to 1,100 or 1,050 levels. (Note: In a CNBC interview just prior to the S&P downgrade, Faber projects S&P 500 index would hit 1,050 to 1,100 in Oct/Nov timeframe.), Currently, he's allocating his personal portfolio about 20-25% each in equities, real estate in Asia, gold or silver, and corporate bonds.

Some Thoughts from EconMatters

As pessimistic as Faber thinking S&P's downgrade is "backward looking" not fully reflecting the actual fiscal state of the U.S., there's Warren Buffett who's blasting S&P, ".... remember, this [S&P] is the same group that downgraded Berkshire," and said "The U.S., which was cut Aug. 5 to AA+ from AAA at S&P, merits a “quadruple A” in a separate Bloomberg interview. Buffett's Berkshire is the biggest shareholder of Moody’s Corp. that just reaffirms the AAA rating of the U.S. on Monday partly responding to S&P's action.

All eyes are on Fitch now to see if it will follow S&P or Moody's making it a crucial swing vote. Things (and markets) could get worse if two out of three major rating agencies end up downgrading the U.S. U.S. fiscal and debt situation is horrendous, and probably deserves a downgrade.

However, to me, a downgrade action needs to be supported with charts and tables showing why the current and projected risk profile warrants a downgrade action and how to rectify, rather than the U.S. politics cited by S&P as its main downgrade thesis (Name one Western country where politics do not come into play in the decision-making process?), not to mention some indications of a possible 'unfair distribution' of this downgrade information.

So far, the downgrade has only added to the stock market turmoil, while driving up Treasury demand. Is this not counter-productive and counter-intuitive? Hopefully, markets would quit panicking like Faber says so not to be dictated by one rating agency's highly debatable conclusion.