Partisan drama is once again center stage
For investors, political drama has been center stage due to the government’s debt ceiling. Although this has become a regular occurrence in Washington, many investors are still understandably nervous. History shows that investors who can stay focused through periods of political and fiscal uncertainty are better positioned to achieve their financial goals.
At the moment, it’s expected that Congress will raise the debt ceiling through the beginning of December. Unfortunately, this means that officials will need to revisit this topic in less than two months, even as debates rage over up to $4.5 trillion in new spending proposals. The fortunate news is that financial markets are taking these events in stride. Regardless of how the current episode is resolved, this is unlikely to be the last debt ceiling debate.
What is the debt ceiling anyway?
The debt ceiling was intended to be a way for Congress to revisit the size of the national debt periodically. It limits the ability of the Treasury to borrow new funds, which forces politicians to acknowledge and address the level of the federal deficit by voting to raise it.
The problem with the debt ceiling debate is that, while it’s going on, it prevents the government from paying its bills. Thus, the real problem is simple: the spending that causes the government to reach the debt limit has already been approved via the budget. This is akin to signing the papers for a new luxury car then requesting an increase to your credit card limit when you receive the bill. For most of us, the decision to buy something can’t be separated from whether and how we will pay for it.
Table: The federal debt has ballooned during the pandemic and might grow further as new spending is approved
Sources: Clearnomics, US Office of Management and Budget
So what can an investor do?
It’s important for investors to distinguish between their political feelings on government spending and how they manage their portfolios. Given that this is how the system works, what matters to long-term investors is whether a game of fiscal chicken will spill over into financial markets — even if the government does not default on its debt.
This is what occurred in 2011 when a political standoff around the debt limit led Standard & Poor’s, a credit rating agency, to issue a warning and then to subsequently downgrade the US debt. Over this period, the stock market fell into correction territory with the S&P 500 declining 19%.
Ten years later, potential default is still held as the worst-case scenario for problems in Washington affecting markets. The S&P 500 returned to its all-time high about four months later, despite on-going challenges related to the global financial crisis and eurozone debt crisis. Debt ceiling debates since then have resulted in much less market volatility despite anxiety and headlines.
Keep your eye on your long-term goals
While investors can’t control what happens in Washington, they can control how they react to headlines as they manage their portfolios. Political events, more often than not, serve only as distractions when managing toward financial goals.
Disclosures
This material, as well as the insights and data within, have been provided to MoneyLion by Clearnomics, Inc.
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