Why is the FTSE 100 ignoring the AAA downgrade?

Some expected the sky to start falling in this morning.

Judging by the pessimistic tone of the BBC reporting of the story, it would have been little surprise if the stock markets and Pound Sterling had plummeted, following the action taken by Moody’s to downgrade the UK credit rating from AAA.

Yet, as I type this, the FTSE 100 index of leading UK company shares is trading up 0.66% at 6,377.31, nearing five year highs once again.

UK equities didn’t crash and burn as a result of the news, which was announced after close of trading on Friday night. In fact, investors seem to have largely ignored it.

But why is the FTSE 100 ignoring the AAA downgrade? We think there are a few reasons for this.

This index might contain UK company shares, but they are companies that do a lot of their business outside of Great Britain.

FTSE 100 companies represent around 81% of listed UK companies by market capitalisation and more than 70% of their revenues come from overseas. It is not a good proxy for the UK economy.

At the same time, ratings agencies are becoming less relevant in the modern world of finance.

The UK was downgraded on Friday evening by Moody’s, the same ratings agency which thought AIG was worthy of a AAA rating and Lehman Brothers deserved the AA rating, right up until they both collapsed.

Ratings agencies still play a role in determining the financial strength and cost of credit for nations and corporations. They have less credibility and influence than they once did.

The impact of the credit downgrade is likely to be felt to a larger extent by Gilts and Pound Sterling; although even investors in these appear to be largely ignoring the move.

The yield on the benchmark 10-year gilt rose by only 0.04% this morning, to 2.16%. This is still very low by historical standards and is being driven largely by the Bank of England asset purchase programme and the continuing ‘safe haven’ status of the UK relative to other nations.

Gilt yields have a long way to rise before reaching the one year high of 2.44% we experienced last March.

Looking at the currency markets, the Pound has fallen by 0.14% against the US Dollar, with £1 now buying $1.51420. Against the Euro, Sterling has fallen by 0.49%, with £1 buying €1.14380.

This represents moderately bad news for holidaymakers this summer, but  good news for British exporters who could experience a growth in demand for their goods and services.

Should investors be worried this morning by the downgrade? Probably not.

Those investing through a well diversified portfolio across the main asset classes should experience little volatility.

The various investment markets appear to have already priced in the news, to a large extent, choosing instead to focus on real news which will influence the value of companies, rather than the opinion of an increasingly discredited ratings agency.

Photo credit: Flickr/Daniel*1977