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The Debt Ceiling Thumbnail

The Debt Ceiling

The debt ceiling debate is in the news every day. We all have to assume that the Republicans and Democrats will negotiate a solution. Markets are acting like they are completely confident it will happen. Less attention is being paid to what could happen to markets following a deal. Those that are paying attention are focused on what happened back in 2011, when President Obama agreed to budget cuts to get a deal with the Republicans of his era. The deal was struck, and the stock market tumbled -18.8% in three weeks. Here’s the chart of the S&P 500 back in 2011. The red line marks the tumble. 

There were extenuating circumstances in 2011, particularly the debt crisis in Europe. The U.S. lost its AAA credit rating. Fear of recession loomed, as it does now. There was also the sudden realization that there was simply going to be less liquidity in the system because of spending cuts related to the debt ceiling deal. 

Bond prices leaped upward, as stocks were tumbling. The TLT, an ETF that tracks the prices of 20+ year U.S. Treasury bonds, jumped up 33% in approximately two months following the debt ceiling deal. The irony of this is that the U.S. credit rating had just been cut, but money poured into Treasury’s anyway, as the safe haven trade. Here’s the chart.

Gold also rocketed upward 30% in about two months. It was also considered a flight to safety trade. 

There are some fears that history could repeat itself in 2023, especially if there are deep cuts in Federal spending proposed. There is also the fear that “Treasury will need to scramble to replenish its dwindling cash buffer to maintain its ability to pay its obligations, through a deluge of Treasury-bill sales. Estimated at well over $1 trillion by the end of the third quarter, the supply burst would quickly drain liquidity from the banking sector, raise short-term funding rates and tighten the screws on the US economy just as it’s on the cusp of recession.” (Bloomberg.com, May 18, 2023)

It's clear that buying long term Treasury bonds and gold were good trades to offset the collapse in stock prices in 2011. Investors who were overweighed to both in July-August 2011 never felt the pain of the stock market collapse. Investors like that were few and far between. 

Stock prices did turn back up after their tumble and the S&P 500 finished up 2.11% for the entire year. Gold prices retreated significantly after their rapid rise in July and August, but also finished up on the year. 

Long term bond prices gave back a little but remained elevated for the remainder of the year. They kept playing their role as a “safe haven” while volatility remained high for stock prices. If stock prices do get more volatile in the near future there is no reason to expect long term bonds to act differently this year. They will likely play the same role now as they did back in 2011.  

All the best to you, 

Paul Krsek
5T Wealth, LLC
Main (707) 224-1340
Cell (707) 486-7333

Disclosure and Disclaimer - Updated last on December 11, 2019 by Paul Krsek:

All return calculations for the S&P 500 were done using https://dqydj.com/sp-500-return-calculator/unless otherwise noted.

All charts used in this newsletter are from Stockcharts.com and annotated by 5T Wealth, LLC

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