Moody's, Fitch Affirm Rating; Issue Warning If Economy Weakens

Dow Jones Industrial Average and S&P 500 Drop Despite U.S. Debt Deal

Aug. 2, 2011 — -- U.S. stocks continued to slide Tuesday in part on concerns about the global economy, before Moody's affirmed its AAA rating on U.S. sovereign debt but lowered its outlook to "negative." Earlier in the day, Fitch Ratings also affirmed its AAA rating. Economists are now waiting to see if Standard and Poor's will follow suit or downgrade the nation's credit rating.

The Dow Jones Industrial Average dropped 266 points, or 2.19 percent, to 11,867 at the end of the day, while the S&P 500 fell for the seventh straight day, down 2.56 percent to 1,254. It's the S&P's longest slump since 2008.

On Tuesday, the Senate passed an agreement to raise the debt ceiling and avoid a default on U.S. debt, following passage in the House on Monday evening.

"The initial increase of the debt limit by $900 billion and the commitment to raise it by a further $1.2-1.5 trillion by yearend have virtually eliminated the risk of such a default, prompting the confirmation of the rating at Aaa," Moody's stated in a report.

Moody's assigned a negative outlook to its rating, saying it could downgrade the U.S. if fiscal discipline weakens in the coming year, further "fiscal consolidation" does not take place in 2013, the economic outlook "deteriorates significantly," or there is an appreciable rise in the government's spending "over and above what is currently expected."

Fitch Ratings confirmed its AAA rating for United States debt over the short-term, but warned of more tough choices coming soon.

"While the agreement is clearly a step in the right direction, the United States, as in much of Europe, must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term," Fitch said in a statement.

Before Moody's and Fitch's reports were released, traders were focused on a morning report which showed American consumers were spending less during June, the biggest one month drop since 2009.

Nick Kalivas, vice president of financial research at MF Global, attributed Tuesday's market reaction in part to a continuation of news showing a lowered economic outlook.

Yesterday, U.S. financial markets were first buoyed by the news of a possible debt limit deal in Washington, but slid after a report on manufacturing showed weak progress for the economy. Today, the possibility of renewed fear of spreading sovereign credit stress in Europe and concerns that China could raise interest rates weighed on stocks.

Kalivas said stocks in the health and defense sectors have fallen due to their exposure to federal budget cuts announced in the debt deal.

"If there's a trigger and they have to institute defense and health cuts, it will likely cut providers not people who receive the benefits," Kalivas said. "It's a sign the regulatory environment may be difficult for the healthcare and pharmacy industries. That sector has not traded well the last couple days."

Shares in hospital company HCA Holdings fell 1.2 percent to $24.64 today.

"Consumer and businesses rally need to regain some confidence and start to spend more if we're going to have a resurrection in the third quarter," Bruce McCain, chief investment strategist with Key Private Bank, said.

Concern has arisen over possible cuts to Medicare and Medicaid spending.

U.S. financial markets began dipping yesterday after the Institute for Supply Management (ISM) issued its monthly index, showing a tepid manufacturing sector. Economists consider the index an important indicator in predicting the manufacturing portion of the economy, said Phil Orlando, chief equity strategist with Federated Investors.

"The ISM number was a game changer because we thought the economy would start to firm in the later summer months, especially as Japan starts to come back," Orlando said.

The ISM index for July fell to 50.9 , which was below the consensus figure of 54.5 and June's actual number of 55.3.

"It was significantly below what the consensus expectation was, even though the street thought the number would be soft," Orlando said.

McCain said the report does not eliminate the possibility of an anticipated improvement in the economy in the third quarter.

"It be more back ended loaded in third quarter than anticipated," McCain said. "We've seen some recent retail numbers that show consumer spending may be improving, which shows more potential improvement for GDP growth. We think it's too early to conclude improvement is not coming."

Monday's manufacturing report followed a weaker-than-expected gross domestic product figure last week. On Friday, the U.S. government said the economy expanded at a disappointing 1.3 percent annual rate in the second quarter after barely growing during the first quarter.

"To be as weak as it was, it gave economists pause in conjunction with the weak economic figure on Friday," Orlando said. "It's just another piece of the mosaic."