On December 17, 2010, Moody’s Investors Service downgraded its credit rating on Ireland by five notches (from Aa2 to Baa1). Given the country’s recent financial calamity, and throughout the entire European Union (EU), Moody’s action seemed quite appropriate. Investors agreed, as the Irish Overall Index (ISEQ:IND) and equities across Europe suffered losses. And, though bad for Ireland, a ratings slash followed by index underperformance feels nothing short of appropriate. Or is it?
Looking deeper at the circumstances, one finds that Ireland received negative press for months prior to the downgrade, and was the beneficiary of “sell” recommendations from the vast majority of analysts around the globe — eventually receiving a bailout from the EU on November 28, 2010 for over $100 billion. So… why the reaction from investors? If the entire globe knew the situation in Ireland, why did we respond negatively to the downgrade? And plainly, why do investors put such faith in rating services that are themselves reactive?
Frankly, my five-year-old nephew could have downgraded Ireland on December 17th. By this time, the financial situation in Ireland had deterioriated past recognition, leading to street protests and emergency meetings of EU leaders. Time after time, investors react to headlines with little (or absolutely no) regard for research or process. Apparently, rating agencies are allowed the convenience of hindsight while investors continuously overutilize credit ratings as a projection tool. Both are of concern. These agencies are allowed to react and adjust, and we treat them as if their crystal ball is more clear than the rest. The reality? Rating agencies are full of financial analysts that can get things wrong (sometimes very wrong), but continue to benefit from the pedistal we have built for them. They react and adjust, but are seldom questioned, at least not for long.
Though this is not an isolated event, Ireland’s downgrade and our customary reaction prompts a learning opportunity for all investors. There are many more downgrades to be spoon-fed to us in the near future. We investors must immediately affect a change of our own — a downgrade of our seemingly unconditional dependency on rating agencies and their reactive reporting.
Jonathan Citrin is founder and CEO of CitrinGroup, an investment advisory firm located in Birmingham, MI. He is an adjunct professor of finance in the School of Business at Wayne State University.
Founded in 2003, CitrinGroup specializes in portfolio management and advises clients on investment and wealth planning.
For more information, call 248-569-1100 or visit www.citringroup.com.