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Add S&P downgrade to a struggling economy, what do you get? Stocks in shock. [VIDEO]

Stocks plummeted Monday, in response to the S&P's decision Friday evening to downgrade the US debt rating from AAA to AA+.

By Ron SchererStaff writer / August 8, 2011

A broker covers his face behind his screen at the stock market in Frankfurt, Germany, on Monday, Aug. 8, the stock index plunged after the opening of the stock market. The Dow, NASDAQ, and S&P 500 have all fallen in response to the downgrade of the US credit rating.

Michael Probst / AP / File

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New York

In the first trading session since Standard & Poor’s lowered the debt rating of the United States from AAA to AA+, investors reacted badly, selling stocks in waves.

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After noon, the widely watched Dow Jones Industrial Average had plunged 318 points to 11,125, as investors ran for cover. Other, broader market indices, including the Standard & Poor’s and the NASDAQ, were sharply lower as well. As its lowest point so far on Monday, the Dow average was off as much as 350 points.

“Investors have a fragile psyche right now,” says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. “Sentiment is extreme on the negative side. Each piece of bad news is causing traders to dump stocks.”

The selling is a continuation from last week, when the stock market lost about 7 percent of its value. The major averages are now down close to 13 percent from their recent highs. If the selling continues, the market will enter “a bear market” phase, which is loosely defined as a loss of about 20 percent.

Although the stock market has dipped sharply in the past without an adverse effect on the economy, falling stock prices adversely impact business and consumer sentiment. This can eventually spill over onto Main Street, as consumers postpone large purchases like automobiles, and businesses decide to hold off large investments.

“Drops in the stock market do not necessarily translate into a loss of confidence,” says Lynn Franco, director of consumer surveys at the Conference Board, a business research group in New York. “But you have to look at the political scenario, the downgrading of the US debt, and the longer-term repercussions. This will not instill confidence.”

The key factor will be how long the stock market falls. The longer the drop, the worse the impact on consumers’ psyche, says Ms. Franco.

The stock market plunge isn't the only disappointing economic news. On Friday, the Department of Labor reported the US economy added 117,000 jobs in July. Although this was higher than many economists had anticipated, it was still considered a “weak” reading, says Franco.

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