Negotiations around raising the debt ceiling have taken center stage in our nation’s news cycle. Despite the intensity of this highly politicized clash, it is worth noting that this is not an unprecedented situation for our government. If past events serve as a reliable guide, a last-minute solution is a probable outcome. However, in the unlikely occurrence that a resolution is not achieved, the potential disruption may be significant – though we believe temporary – as our politicians will undoubtedly scramble towards a compromise.
Regardless of the outcome, Cheviot portfolios are built with the goal of being resilient, positioned with a combination of durable companies and proper weighting across asset categories to successfully weather the storm. And during the last debt ceiling debacle, we used the market’s decline as a buying opportunity.
As you are aware, the debt ceiling serves as a legislative cap, instituted by Congress, on the overall debt that the U.S. Government is allowed to accumulate, comparable to a credit limit on a credit card. It establishes the maximum amount that can be borrowed to meet existing obligations, including to its citizens and to the international community, with our debt nearing the $31.4 trillion cap as of March 2023. It is worth noting that this is not merely a national concern. Given the significant role of the U.S. economy and U.S. Government bonds across the world, any fluctuations or uncertainties surrounding this debt limit have the potential to affect the global economy.
Historically, the prospect of a debt ceiling crisis is not novel but a familiar narrative in the annals of U.S. fiscal policy. This presence of an imminent crisis made its appearance notably during two previous instances – in the mid-1990s and the aforementioned 2011, serving as significant chapters in this ongoing saga. Despite the debt ceiling’s intended role as a fiscal constraint, there has been consistent escalation of this limit.
In the mid-1990s, during the speakership of Newt Gingrich, the Republican-majority Congress found itself in a headlong dispute with President Clinton’s administration over the debt limit. The standoff, prompted by an insistence to incorporate spending cuts, led to a partial government shutdown, displaying the potential implications of a debt ceiling stalemate.
Again, in 2011 under Speaker John Boehner, a similar standoff occurred. This time, it was with President Obama’s administration over the extension of the debt ceiling. Boehner’s attempt to tie substantial spending cuts to the debt ceiling increase was reflective of the events that transpired in the mid-1990s. This resulted in a last-minute resolution, but not before it triggered an unprecedented downgrade of the U.S. credit rating by Standard & Poor’s.
Today, what consequences could we face if Congress and the White House are unable to find common ground? Essentially, the U.S. government may exhaust its funds, possibly leading to furloughs or layoffs of government workers, delayed principal and interest payments on outstanding debt, suspended contributions to government pensions, halted disbursements to businesses and individuals, or severe budgetary cutbacks. Any of these scenarios could ignite an economic tremor, felt not only within the U.S. but across the globe. Naturally, this predicament prompts us to speculate whether the stock market has already factored in a potential governmental failure to raise the debt ceiling. Though markets often act as prescient seers, their predictive accuracy is not always impeccable. The last time Congress missed a resolution deadline, the stock market reacted with a potent, but fleeting, convulsion.
Is the stock market today whistling past the graveyard of a debt ceiling crisis? Market participants are not selling stocks en masse ahead of the debt ceiling deadline for various reasons. For one, the 2011 experience taught investors that the market’s decline presented intelligent buying opportunities. (We capitalized on the tumult, buying several different companies during the fallout of 2011.) As such, many investors today are afraid to sell for fear of missing a post-deal rally. Furthermore, a stock market that is not ignoring danger but is instead looking past it, might actually be inviting it. Here’s how: historically, a rapidly sinking stock market in times of crisis causes policy makers to respond quickly. In today’s buoyant stock market, policy makers feel no exogenous pressure of imminent distress from financial markets. In response, they may be slower to act which in turn may even foment a missed deadline.
As Yogi Berra famously said, “It’s tough to make predictions, especially about the future,” and so we cautiously predict this situation will be resolved like the ones before it. Looking out past the month of June, for investors there are two considerations that we expect to reassert themselves as most important once the debt ceiling shenanigans are behind us. Those two are the direction of interest rates – specifically, how much further will rates rise, and the fate of the overall economy – specifically, can it avoid recession? The former will greatly impact the latter.
In these turbulent times, our commitment to our disciplined investment philosophy remains resolute, aiming to provide you with financial growth over time and peace of mind along the way. We also stand ready to capitalize on potential opportunities, making acquisitions of great companies at intelligent prices should behavior in Washington D.C. cause volatility in financial markets. If you have any questions or would like to discuss your portfolio in greater detail, please don’t hesitate to contact us.