Fisher Investments Canada reviews what credit ratings mean for investors

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In June 2020, credit ratings agency Fitch downgraded Canada’s sovereign credit rating, citing the country’s “deteriorating public finances resulting from the coronavirus pandemic.”1 This was the first time Canada didn’t receive Fitch’s top mark since August 2004, as the country had been one of a few countries with the highest ratings from all three main ratings agencies – spurring some questions about Canada’s long-term fiscal picture. This is all quite off target. Corporate credit ratings are late-lagging opinions with very little market influence, so investors should tune them out.

Credit rating agencies assess debt issuers’ creditworthiness and the risk they fail to pay interest or repay principal in a timely manner. The issuers include private corporations and regional and national governments. Fisher Investments Canada will focus on governments here.

Today, the largest agencies are Moody’s, Standard & Poor’s (S&P) and Fitch, collectively known as The Big Three. Each uses slightly different criteria, but the ratings themselves tell similar stories. As Exhibit 1 shows, agencies rate debt with letter or alphanumeric grades. The bonds perceived to carry the lowest default risk are rated highest and grouped as “investment grade,” and vice versa for the riskiest bonds, which are graded “junk,” “high-yield” or “non-investment grade.” Lower designations imply an issuer has failed to meet its obligations on the bond in question.

Exhibit 1: Big Three’s Credit Rating Scale

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The Big Three’s reviews typically garner lots of attention in publications Fisher Investments Canada reviews. This influential legacy dates back to the mid-1970s, when the U.S. government granted the agencies special status in financial regulation as nationally recognized statistical ratings organizations.2 This was meant to help investors assess issuers’ creditworthiness, but it also embedded these firms into financial and securities law, which hasn’t changed much since.3 This influence has carried to other parts of the world, as many pensions and other institutions have credit-quality rules in their investment policy statements. In 2012, Canadian securities regulators recognized the Big Three – along with Canadian firm Morningstar DBRS – as designated rating organizations (DROs).4

While these agencies’ views attract headlines, their market influence is limited in our view. The reason: They incorporate late-lagging, widely known criteria into their analysis. For example, things such as demographics, budget reserves, economic growth forecasts and political stability factor into ratings. Many of these are public data and not new to markets, which price in and reflect widely known information.

Fisher Investments Canada reviews of history shows rating agencies’ limited effect on markets. On Aug. 1, 2023, Fitch downgraded U.S. debt’s long-term rating from AAA to AA+, citing weak economic forecasts and months of widespread speculation that the U.S. could default on its debt.5 If this was some major, unseen negative, U.S. government debt yields would have spiked, since higher bond yields represent a higher risk premium (meaning investors demand higher compensation for holding riskier debt). But that didn’t happen. U.S. 10-year Treasury yields started rising in March, months before Fitch’s downgrade.6 They rose through October before falling to pre-downgrade levels at year end.7 One year on, 10-year Treasury yields were below pre-downgrade levels.8 There was no discernible downgrade effect in yields.

Or consider Fitch’s downgrading of Canadian debt in June 2020.9 At the time, Canadian 10-year yields were at decade-low levels.10 Yet the news didn’t send yields immediately soaring.11 Moreover, though Canadian yields did rise following a July 2020 low, that mirrored climbs in other major Western nations – a reminder that global trends tend to matter more than local ones.12

Moreover, ratings are just opinions – often groupthink. Since raters often have similar backgrounds, criteria and training – and they compete with one another for corporate ratings – they often draw similar conclusions. For instance, Moody’s upgraded Greek debt from Ba3 to Ba1 on Sept. 15, 2023, just one week after DBRS bumped up its Greek rating to investment grade.13 Same goes with French debt in October 2024: Moody’s downgraded its outlook just two weeks after Fitch.14 But opinions aren’t predictive and don’t affect what Fisher Investments Canada’s reviews of market history show are bonds’ main drivers: interest rates, inflation, broader inflation expectations or issuers’ actual ability to service debt.

Markets are a more effective tool, as Fisher Investments Canada’s reviews of market history suggest they look three to 30 months ahead. For instance, publications Fisher Investments Canada reviews monitor the spread between long-term German bund yields and that of other euro zone countries to weigh relative riskiness, given Germany’s reputation for economic stability and creditworthiness.15 Consider that, before and during the eurozone debt crisis, sizable spreads formed between 10-year bund yields and those in the countries that got hit hardest – Portugal, Italy, Ireland, Greece and Spain. We believe this was signalling markets were prepricing the upcoming turmoil.16

While credit ratings aren’t predictive, widespread reactions to them can hint at broader sentiment. Yet that is about all we think investors can glean from such flawed, backward-looking opinions. In Fisher Investments Canada’s view, investors should tune them out and look to markets instead.

Read Fisher Investments Canada's additional reviews of markets and financial topics.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

Fisher Investments Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.

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