U.S. Stress Testing

Global Insight’s Macroeconomic Service calculated the U.S. hard-landing scenario as occurring when housing prices and sales drop below the baseline forecast, leading to a retreat in consumer confidence, and thus, consumer spending. Capital spending is also weaker, as firms respond to a bleaker outlook by cancelling long-term projects. These effects, in combination with near-term oil prices shooting above $100 per barrel, send the economy into recession. The World Industry Service then used these macro results as drivers to distribute the economic impacts down to industries, and used stress-testing techniques to analyze the implications for how the credit profile of the S&P 500 portfolio would respond under this scenario.

The industries showing the greatest deterioration in profitability compared with the baseline forecast are concentrated in oil-dependent and commodity industries, as well as in construction. Petroleum refineries, refined products, plastics, and synthetic resins will all suffer significantly from an oil-price hike. Energy, industrial chemicals, and metals are the industries that are most sensitive to inflections in economic growth, having already been under pressure from foreign competition in the United States at the end of 2007. The smallest impacts on profits in this scenario versus the baseline are seen in social and personal services, restaurants and hotels, and communications.

The result of our stress testing simulation of a hard-landing scenario in the United States is that a portfolio of the S&P 500 would see deterioration in credit quality during 2008. Among the 10 broad sectors within the S&P 500, most of the migration in credit quality is seen in the energy, materials, and consumer discretionary sectors. This is very much in line with the ranking of industries whose profits are affected the most. The S&P 500 portfolio has very few construction companies, so their sharp decline in credit quality has a limited impact upon the much broader industrial sector in total.

Our results show that industries within construction, real estate, banking, manufacturing, and metals and energy mining would be hit hardest. These industries show the largest deterioration in sales, profits, and credit quality in the hard-landing scenario compared with the baseline forecast. The smallest impacts are seen in social and personal services sectors, wholesale trade, and transport, storage, and communication. When these results are translated into their impact on the corporate credit quality of the companies in the S&P 500, the composite S&P 500 portfolio in aggregate drops one notch in credit quality, from A- to BBB+.