America received a credit downgrade for the second time in history... But it shouldn't kill the bull run in stocks.
See, around the globe, sovereign debt is rated by three major credit agencies – Fitch Ratings, Moody's, and Standard & Poor's.
Until recently, all three agencies rated U.S. sovereign debt as "AAA" or "risk free." But in 2011, Standard & Poor's downgraded U.S. debt to "AA+," the next tier lower.
The market reaction was so severe that it became known in Wall Street circles as "Black Monday 2011." The S&P 500 Index plunged about 7% the morning after the downgrade.
But one year later, stocks were up about 16%. In other words, the credit downgrade was a buying opportunity. And today, history is repeating itself...
This month, Fitch has lowered its U.S. debt rating to "AA+" in an echo of Standard & Poor's 12-year-old decision.
Now, the Big Tech companies driving this year's rally are showing signs of turning lower...
Yet history says a quick "Black Monday" style sell-off is unlikely from here. If the drawdown continues, it will most likely take a few months... And it will still likely lead to a great buying opportunity in stocks overall.
Let me explain...
When Fitch issued its credit downgrade, tech stocks dipped for the first time in months...
We can isolate this move by looking at the Nasdaq 100 Index. This includes 100 of the biggest companies in the tech-heavy Nasdaq Composite Index... Think giants like Apple (AAPL), Alphabet (GOOGL), and Nvidia (NVDA).
The Nasdaq 100 has surged 37% year to date. That's a massive rally – more than doubling the S&P 500's return so far this year. But the bull run is now threatening a reversal.
We can see this using the 50-day moving average (50-DMA). This signal tells us an asset's average price over the last 50 days. It smooths out daily moves so you can see the broader trend more clearly.
Today, the Nasdaq 100's 50-DMA is still in a clear uptrend. But last Wednesday, the index's price fell below that trend line for the first time since March. Take a look...
This slump hints at a breakdown in the Big Tech rally. But don't get too bearish on the sector just yet.
In fact, if the drawdown persists, it will be a great chance to buy...
To test this, I looked at similar incidents – specifically, where the Nasdaq 100 fell beneath its 50-DMA after spending three months or more trading above it. Then, I checked the forward returns from those dates.
It's pretty routine for the Nasdaq 100 to dip after a three-month rally. I identified 28 such price moves since 1990... which means they happen almost every year.
Sure enough, the index underperformed after 50-DMA breaches like last Wednesday's. However, the drawdowns rarely lasted for long. Take a look...
The Nasdaq 100 has been a great investment since 1990, returning about 3% every three months. After a signal like Wednesday's, that three-month return was cut in half.
But if you're investing for longer than three months, history says you shouldn't be too concerned about the recent price action...
The index tended to rebound fully after six months. And it outperformed by a percentage point on average one year after the signal.
Plus, a decline in the index was far from guaranteed. These tech stocks were still positive after three months in about 64% of cases... and positive after a year 89% of the time.
So despite the credit downgrade, this probably isn't the peak for the Nasdaq 100 – the stocks that are driving today's bull market. It could be the start of a near-term drawdown... But the current rally looks healthy in the longer term.
In other words, don't worry too much about what the downgrade means for stocks. History says prices should keep climbing from here... And if the Nasdaq 100 dips further in the next three months, it should be a great time to buy.
Good investing,
Sean Michael Cummings
Further Reading
Last year's bear market sent stocks on a rare losing streak. But that streak broke in April, kicking off a huge uptrend. Most important, moves like these have led to major outperformance over the next year... Read more here.
"It's refreshing to see the economic data beat expectations again – especially after last year's pain," Brett Eversole writes. A broad collection of economic data has been topping the forecasts. And that's great news for investors... Learn more here.
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