Moody's Just Downgraded the United States' Pristine Credit Rating -- Here's What History Says Happens Next for Stocks

There's never a dull moment on Wall Street. Earlier this year, the bulls could do no wrong, with the benchmark S&P 500 (SNPINDEX: ^GSPC) climbing to an all-time record high. Not long thereafter, a historic bout of volatility arrived.

In April, the steady-footed S&P 500 endured its fifth-worst two-day percentage decline of the last 75 years. But true to form, less than a week after this mini-crash, the iconic Dow Jones Industrial Average (DJINDICES: ^DJI), the S&P 500, and the growth-focused Nasdaq Composite (NASDAQINDEX: ^IXIC) all registered their largest single-day point gains since their respective inceptions.

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Short-term movements in the Dow Jones, S&P 500, and Nasdaq Composite are aptly described as predictably unpredictable. It's simply a matter of which shoe drops next.

Image source: Getty Images.

On Friday, May 16, after the markets had closed for the week, Wall Street and investors got their answer in the form of a Moody's (NYSE: MCO) downgrade of the United States' credit rating.

While there have been countless takes on what this credit-rating downgrade means for the U.S., history is relevant, too -- and it points to a very clear directional move for the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite.

The U.S. has lost its pristine credit rating

To be transparent, Moody's debt downgrade isn't the first the U.S. has endured. In fact, Moody's was the last among the major credit-rating agencies to have kept America at its highest possible rating (AAA).

In August 2011, Standard & Poor's (S&P), a division of the more familiar S&P Global, lowered its credit rating for the U.S. one level, from AAA to AA+. Nearly 12 years later to the day, in 2023, Fitch Ratings downgraded the U.S. credit rating by a corresponding AAA to AA+. Moody's became the last on May 16 with its credit-rating reduction from AAA to AA1, which is also one level below the highest possible rating.

Moody's downgrade brings to the forefront a number of headwinds working against the U.S. economy.

For starters, the federal government has been operating in a continual state of deficit, regardless of whether the U.S. economy is rapidly expanding or growing at a snail's pace. With the exception of 1998 through 2001, the federal government has spent more than it's brought in every year since 1970. Since the financial crisis in 2008-2009, federal deficits have really ballooned and shown no signs of slowing. This simply isn't sustainable.

US Government Surplus or Deficit data by YCharts.

Secondly, the prospect of rising interest rates makes America's perpetually growing national debt all the more concerning. The Federal Reserve's monetary policy affects more than what you pay in interest on your credit card. The central bank's efforts to curb historically high inflation in 2022 and 2023 also made servicing U.S. national debt costlier.

The third and final factor weighing on America's financial health is a series of ongoing demographic shifts. For more than a quarter of a century, the number of migrants entering the country has been declining -- and both legal and undocumented migrants have positively impacted America's social programs. Meanwhile, the U.S. fertility rate hit an all-time low in 2023. Fewer workers entering the labor force at a time when baby boomers are retiring is putting added pressure on revered social programs like Social Security and Medicare and increasing government outlays.

But -- and this is a pretty big but -- Moody's rating is underpinned by an assumption:

The U.S.' institutions and governance will not materially weaken, even if they are tested at times. In particular, we assume that the long-standing checks and balances between the three branches of government and respect for the rule of law will remain broadly unchanged. In addition. we assess that the U.S. has capacity to adjust its fiscal trajectory, even as policy decision-making evolves from one administration to the next.

In other words, even though the U.S. no longer boasts the highest possible credit rating, Moody's still believes it's a financially strong entity.

Image source: Getty Images.

History portends what comes next for stocks following a U.S. credit downgrade

So what happens to stocks when a major credit-rating agency sours on the U.S. economy?

Admittedly, we're dealing with a somewhat limited data set. Since this marks only the third downgrade from the previously pristine rating, no correlations, in terms of gains or losses in equities, can be guaranteed. Nevertheless, the S&P 500 made a very decisive directional move following each of the previous two credit-rating downgrades.

Based on data summarized by Carson Group's global macro strategist, Sonu Varghese, and reposted on social media platform X (formerly Twitter) by its chief market strategist, Ryan Detrick, the benchmark S&P 500 fell 2.6% one month after its Aug. 5, 2011 downgrade as overall market volatility increased. Likewise, the S&P 500 dipped 1.2% a month after Fitch's downgrade on Aug. 1, 2023, also largely due to higher volatility and prevailing economic uncertainty.

But it's a completely different story if investors widen their focus. As you'll note in Detrick's post detailing Varghese's summary, Wall Street's leading stock index surged by 18.8% 12 months after the S&P downgrade in August 2011 and rocketed 20.8% higher one year after the credit downgrade from Fitch. On average, the S&P 500 has effectively doubled its average annual return since 1950 in the 12 months following a debt downgrade from a major credit-rating agency.

Nice summary of previous debt downgrades from @sonusvarghese.

S&P 500 up 18.8% and 20.8% a year later is a solid takeaway. Don't get too worked up over this.

But also, check out how yields dropped over the next 12 months. pic.twitter.com/BlAN82oHqu

-- Ryan Detrick, CMT (@RyanDetrick) May 19, 2025

To reiterate, this is a very limited set of data, and there isn't a predictive tool or metric on the planet that can guarantee what comes next for stocks. If there were, every investor would be using it.

Yet what Varghese's summarization of events demonstrates is the nonlinearity of economic and stock market cycles.

Worries about rising national debt levels are nothing new -- and they aren't going away anytime soon. Despite these concerns, the U.S. economy has continued to grow.

Even though headwinds are always waiting for the U.S. economy, history conclusively shows that recessions are short-lived. Since World War II ended nearly eight decades ago, the average U.S. recession has lasted roughly 10 months. On the other hand, the typical period of economic expansion has endured for approximately five years.

Investors wagering on U.S. economic growth have consistently had the odds in their favor, as well. Calculations from the researchers at Bespoke Investment Group show that the average S&P 500 bear market has lasted just 286 calendar days (roughly 9.5 months) since the start of the Great Depression in September 1929. Conversely, the typical bull market has stuck around for 1,011 calendar days, or 3.5 times longer, over the same stretch.

Worries may persist for a few weeks about Moody's U.S. credit rating downgrade, but the historical indicators of the U.S. economy, the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite, continue to point higher.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Moody's and S&P Global. The Motley Fool has a disclosure policy.