Cityunslicker – Will Moody’s sovereign downgrade of the UK finally put an end to the 5 month rally?

My blog this week is not such a hard call to make, the loss yesterday of the UK’s AAA rating, in this instance a downgrade by Moody’s to Aa1, will have some very predictable effects. Firstly, both the other main agencies are likely to follow suit as the UK is presently on negative watch and its public fiinances are deteriorating. This means there is more short-term bad event news to come in the next couple of weeks.

The graph below shows the sovereing debt reactions of other countries that have suffered the ignominy of a downgrade and so anyone who thinks the UK is going to keep record low gilt yields is in cloud cuckoo land. As real rates rise this will have a negative impact on the Governments plans – it may perhaps result in more QE, but the long-term trend is set for a reversal in low bond yields. The overall macro impact will not be good.

Even the politics is bad – if the downgrade further reduces the chance of a Tory re-election and instead a return of the crazed Ed Balls, then the markets will be even more sombre…

However, there is an even better reason to sell the FTSE and that is because it is nearly March. In each of the last three years, human optimism has kicked in for a Santa Rally and then a mad January and February as eveyone wants to belive that this time it is different – this year will be the year that the effects of the financial crisis start to leave us blah blah… And of course, each year disappoints as the debt overhang is simply monstrous.

The script usually goes – Q1 GDP numbers start to disappoint, we realise that the Euro area is still in trouble and the UK is still not having any meaningful impact on reducing its debts despite the austerity programme.

Then. by the mid-year as the usual suspects line up, the summer months of low volume provide the stabilisation period before we build up to a Santa rally again.

Given the historic economic reality that it taks 7 years to recover from a financial crisis, together with overbought markets and modestly stretched valuations, the chances of a March correction were high anyway – with the UK debt downgrade, it is, in my opinion, now baked in.

Tin Hats all round.