Stocks OK Despite Debt Downgrade

Stocks started off the week in panic mode, as rating agency Standard & Poor's (S&P) cut its outlook the U.S. debt rating to negative. While it's not good to have your debt outlook downgraded, it's not time to panic ... not yet, anyway.

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A Wake Up Call
If anything, the move by the S&P should serve as a wake-up call to our elected officials that the country's debt problems are not a bipartisan issue, but a partisan one. The downgrade by the S&P does not change the current AAA rating of U.S. debt. But it does put the world on notice that if our debt issues aren't tackled quickly and aggressively, there is a reasonable probability that the AAA rating will be lost over the next few years. As a result of this news, stocks opened up the week down nearly 2% at one point. While stock market volatility is not something to be concerned about over the long-term, if you are buying good businesses at attractive prices, this news is not to be taken lightly. On the other hand, it's probably not enough news to trigger any sort of panic selling.

The World Will Not End
Indeed, an ultimate debt downgrade is not good for the economy, which is not good for business. But the world not will shut down. To be sure, maybe now the U.S government will really get going on addressing this issue by 2013, which is when the triple-A rating could be lost. That would lead to higher interest rates for the country, consumers and corporations. Businesses that rely regularly on debt markets may not far so well. But blue chips with quality balance or durable businesses may stand out from the rest.

Microsoft (Nasdaq:MSFT) is a cash cow that has taken advantage of the low interest environment to borrow funds cheaply. The company will report earnings next week. But with nearly $30 billion in net cash on the balance sheet, it does not have significant interest rate risk. Pfizer (NYSE:PFE) is another name that generates enough cash flow to support it needs and has minimal debt relative to its cash flows. Pfizer has generated an average of $14 billion in free cash flow per year over the past three years against $17 billion in net debt.

Amidst higher interest rates, people will likely continue fixing their cars, buying medicine and other necessities. Names like AutoZone (NYSE:AZO), CVS Caremark (NYSE:CVS) and Walgreens (NYSE:WAG) will benefit from providing for those needs. These are dominant businesses in their industry, with long-term track records of success.

The Bottom Line
Fixing the debt problem of the largest economy on the planet is a serious issue, and if left unchecked, then businesses will suffer. But hundreds (if not thousands) of U.S. corporations will be able to navigate the storm. It's prudent to be concerned, but it might not yet be time to panic. (For related reading, take a look at Bond Rating Agencies: Can You Trust Them?)

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