Making Sense of the Government Shutdown and the Debt Ceiling
The markets seem to be taking the budget-related government shutdown that began over a week ago in stride. But the realization that legislators in Washington are posturing for another battle—this one over raising the debt ceiling limit—continues to weigh on investors.
The government has shutdown 17 prior times, all between the years 1976 and most recently twice in 1994. Imagine selling all of your investments over those periods, incurring trading costs and, in taxable accounts, capital gains taxes. Forbes recently posted the returns of the Dow Jones Industrial Average during the days of the historical shutdowns. The average daily return while under shutdown was .03%, the exact same as the daily return from all of 1976 through October 3, 2013. In summary, the market’s reaction was no different when the government was closed than when it was working!
The Treasury Department, in a report issued on October 4, compared the possible economic effects of the current debt ceiling debates to those that occurred in 2011. During the 2011 debate period, consumer and business confidence dropped, the stock market declined while volatility increased, and interest rates rose. However, as pointed out in the report, the economic environment in 2011 was also less favorable than today’s, with concerns about European debt stability at peak levels. While the question as to whether to raise the debt ceiling or not has been debated in history, Congress has never voted against it to meet our country’s obligations. Therefore, history can offer no guidance on how the market would react if such an event were to occur.
It is uncertain times like these that investors must remind themselves that whatever they think they know about the current state of the economy or geopolitical landscape, the market already reflects all that is knowable and has incorporated it into securities prices. Prices then only move in response to new information, or surprises. And since surprises are by definition unexpected, movements in prices cannot be identified in advance. We do know that any short-term events, whether related to the economy or future government action or inaction, are unlikely to have an impact on long-term corporate earnings. Understanding this is what leads us to rebalance by purchasing stocks as they are falling, which is the exact opposite of what investors’ emotions are telling them.
With so much emphasis on protecting portfolios from losses due to volatility, one can easily forget that markets can run up just as quickly as they fall, often leaving those who decided to sit out faced with a new forecast of when to jump back in. One only has to look to yesterday’s market rally to illustrate how quickly markets can change; after a string of negative days, the Dow shot up 323 points.
While we are absolutely sympathetic to people’s natural emotional tendencies, we know that our job as advisors is to keep our clients’ emotions from derailing their long-term financial plan. Warren Buffet was not nearly as sensitive when he had this to say about listening to forecasters in a 1992 letter to shareholders: “We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie [Munger] and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grownups who behave in the market like children.” For now, it seems most of the grownups behaving like children are on Capitol Hill.