Keystone's Weekend Reconaissance 12/17/11 - Potential S&P Downgrade of France Debt

The mouse that roared. Traders are walking on eggshells waiting for the S&P rating agency to downgrade France. The indexes bounced at the open both Thursday and Friday only to trail off lower by the close due to the S&P downgrade rumors. Yesterday the fear was elevated as traders expected an announcement by S&P after Friday's close, but, alas, the evening came and went without a peep from S&P.

This latest market fear began 12/5/11 when S&P placed 15 of 17 European nations on negative credit watch. The big shock was the grouping of Germany and France into the mix, the two top economic powers in the euro zone.  The fear in the near term is not so much Germany, but a France downgrade. Fitch and Moody's rating agencies announced downgrades on Friday of various nations which only served to heighten the anxiety.

The repercussions are serious since the EFSF (European Financial Stability Facility) has a comingled relationship that depends on the triple A ratings of France and Germany to maintain the current relative stablity in the region while finding a way out of the debt drisis mess. A France, and heaven-forbid, Germany, downgrade would be devastating.

Let's look back at exactly what traders fear, using the U.S. downgrade event this summer as a guide. Here is Keystone's writing as the U.S. downgrade occurred on Friday evening, 8/5/11, resulting in a 7% drop in the SPX and 6% drop in the SPX on Monday:

"On 8/5/11, Friday, markets attempt a recovery rally but it runs out of steam at lunchtime as a rumor circulates the trading floor that S&P has notified the U.S. Treasury that it was planning to downgrade the U.S. credit rating. A draft of the analysis was given to the White House.  The White House identified a mathematical error in the analysis but S&P said the error has no impact on their decision and after the markets closed for the week, S&P downgraded the U.S. This sent the government, traders and the media into a tizzy all weekend long worrying about the effects on the markets for Monday’s open. The SPX loses the 1200 level today.

On 8/7/11, Sunday evening, Asian markets open lower and U.S. futures plummet. The ECB announces that it would ‘actively implement’ its bond-buying program. Italy and Spanish bonds rally early Monday morning in anticipation of the ECB entering the market.

On 8/8/11, Monday, markets collapse at the open as the negativity from the S&P downgrade all weekend long causes traders to sell first and ask questions later.  The SPX closes at 1119.46, dropping 80 points, or 6.66%, which many media analysts immediately highlight as the satanic 666. The Dow Industrials plummet 635 points, or 5.6%. Huge down day for the indexes."

Thus, traders have reason to worry. An S&P downgrade of France, although the event will not be as drastic as the U.S., will be significant.  The next debate is how much is priced into equities already? Part of the downgrade is but not all of it. Suffice it to say that global equity markets wil sell off if/when the France downgrade occurs.

As described in the U.S.'s fractal presented above, the S&P does provide an early warning system to notify the company or country of the impending news.  This is another reason why a Friday night announcement was/is anticipated since it gives the entity a couple extra days time to prepare for the coming tidal wave of financial implications.

What does all this mean and where are we now?  The Friday S&P downgrade of France did not occur.  It is unclear as to whether or not the S&P has notified France of an impending downgrade. Perhaps France found a mathematical error in the analysis, like the U.S., but this time the S&P agrees and has pulled the wolves off, for now?

The S&P may downgrade this weekend, perhaps even as this article is written, but if they were to do so one would think it would have already occurred last evening.  This opens the door to the possibility of the France downgrade announcement coming this week.

Another part of this saga is the Wall Street rumor mill which sports a batting average of correctness that only a pitcher would accept. Each story becomes more and more embellished as it passes from one traders' mouth to anothers.  Any phrase or words can morph into something not at all resembling fact by the time it grinds thru and exits the rumor mill.  There is also the personal interest portion for this saga, traders talking their own book.  Traders short a boatload of euro's have a vested interest in seeing the S&P France downgrade occur, or, at the very least, the rumor provides time to reduce those heavily-shorted euro positons since the actual worry is that the euro is about to pop. In fact, the euro daily chart actually favors a positive divergence bounce now.

So this downgrade talk for France will be a major character in this weeks trading soap opera. To continue the deductive reasoning theme, and considering that the holiday's are upon us, surely S&P will not play the part of Scrooge and announce the France downgrade this coming Friday the eve of Christmas Eve? Or the following Friday, the eve of New Years Eve? By the S&P not announcing the downgrade of France last night, they may be pushing it off into the new year.  The remaining window is likely early this week, Monday and Tuesday, for the S&P to step up and take a dump in everyone's Christmas Cheerio's. S&P, however, may choose to not be the Scrooge and perhaps traders are too worried in the near term about the downgrade and that it will actually be a January event. Only time will tell.

Thus, boiling down all this hot air into capsule form, look for a possible announcement by the S&P for a downgrade of France debt early in the new trading week, if it does not occur, it probably will not occur until January. Thus, the market fear will be unwarranted, for now, and equities, and the euro can experience a countertrend bounce, perhaps the much-awaited Santa Claus Rally, although it may be more of a Santa Claus Sideways.

The comical aspect is that these are the same rating agencies that turned a  blind eye to the subprime crisis, stamping triple A's on anything with a pulse, and in fact, are partly responsible for the cascading housing funk that we continue to find ourselves in currently and will so for probably another half decade. The rating agencies are busily trying to make themselves relevant again, and, judging by the reaction in the equities markets on Thursday and Friday, they are relevant despite their poor track record. Time to scan the news wires again to see if S&P is Scrooge or perhaps Baby New Year instead holding a scythe.