What Do AA+ And AAA Credit Ratings Mean?

It was a Friday night in August, 2011, finance professionals — accompanied by pretty much everyone — was kept awake after Standard & Poor’s announced that it was downgrading the U.S. debt from AAA to AA+. The news sent shock waves across the world, and those vibrations were even louder that following Monday, which left the market down over 6% by the end of the day. Yet that market decline was benign compared to the individual beatings some stocks endured.

Now, it’s China’s turn. On Wednesday, May 24th, 2017 the rating agency Moody’s downgraded China’s credit rating as growth slows and debt increases. So, why do people care about this and what do the ratings mean?

In terms of the U.S. paying its debt obligations, a drop from AAA to AA+ is noneventful. The U.S. 10-year bond yield was down 0.2%, meaning that investors actually flocked to the safety of Treasuries. The fact that the U.S., the world’s largest economy, went from AAA to AA+ for the first time in history is the big deal. In terms of stature, the downgrade was painful. What that loss of AAA prestige means for investors going forward is anyone’s guess. The $64 million question now is whether the other major rating agencies, Moody’s (NYSE:MCO) and Fitch, will follow S&P and issue their own downgrades. Naturally, affirmation by one or two of the other rating houses would not be a good thing.

Apparently, an AAA credit rating isn’t spectacular either, at least not now. As it now stands, only four U.S. corporations have a AAA rating: Microsoft (Nasdaq:MSFT), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ) and Automatic Data Processing (Nasdaq:ADP). As the S&P plummeted 6%, having a AAA credit rating didn’t mean much. Exxon shares declined by over 6% thanks in part to oil dropping to $81 a barrel. Microsoft shares, despite having what the government would call a surplus of nearly $30 billion, dropped nearly 5%. The best performer was JNJ, which managed to end the day off only 2.5%.

So whether you hold an AAA or AA+ rating, the difference didn’t seem to matter. The market was upset and emotional, and the result was a panic-driven day like the end of 2008. What always matters in this game is valuation and patience. Sticking to the simple philosophy of buying an asset below its long-term intrinsic value will ultimately lead to satisfactory results. It’s a philosophy that is indeed simple to understand yet difficult to execute for most investors. But Mr. Market may be giving investors another opportunity to get greedy. (For additional reading, see A Brief History Of Credit Rating Agencies.)