Tue 12/6/11 10:34 PM – Ratings Agencies and the Eurozone

The stock market acts like it wants to go higher but yesterday’s announcement that ratings agency S&P has put 15 European nations on negative credit watch chopped a nice rally in half. Of the 17 Eurozone nations only Cyprus and Greece escaped being included – Cyprus because it is already on negative credit watch and Greece because it already has a junk rating. Countries may be in for a one or two-notch drop during the next three months from their current individual ratings. The watch is in effect for several reasons such as tightening credit and other systemic issues, including political disagreements.

Then today S&P announced it was putting the EFSF European bailout fund on negative credit watch as well. That’s a no-brainer because its credit rating depends on the AAA rating of Germany, France, Austria, the Netherlands, Finland and Luxembourg, the biggest backers of the EFSF. Their combined contributions are just shy of 60% of the total funding. If the country ratings drop form AAA, then it would be hard for a vehicle backed by them to have a AAA rating.

Remember when up until 2009 junk mortgages were packaged together and the package was then rated AAA instead of reflecting the ratings of the underlying mortgages? The whole thing should have been rated junk. Well, ratings agencies learned their lesson somewhat.

Ratings agencies are viewed with fear and loathing. Fear, because interest rates are tied to the strength of the rating, loathing because ratings agencies are slow to react, sometimes badly wrong and blamed by those whose ratings were cut. That said, they are the most objective and easy to find opinion on creditworthiness.

Personally, I think ratings for most European countries and the US are too high already.

As far as investing goes, stocks really want to head higher on optimism about the Friday meeting of Eurozone members and the news of a preliminary agreement in principle. But these news stories have cut the rally down, though not by much. Yesterday was still an up day and today is up slightly.

The S&P news really helps put pressure on this weekend’s meeting and that is actually favorable for gaining a consensus and perhaps for getting a stronger agreement. That would be good news for the markets.