Debt Ceiling Dilemma

Some of us have painful memories of 2011 when many people first learned of the arcane piece of federal legislation called the debt ceiling (or debt limit), which caps the amount of money the U.S. government can borrow. Contentious (that’s putting it nicely) negotiations in Congress led to Standard & Poor’s decision to cut the U.S. credit rating from AAA. Those events drove the S&P 500 Index down 19.4%—just shy of the 20% threshold for ending the bull market [Figure 1].

A similar dynamic occurred in 2013. But after navigating the fiscal cliff at the end of 2011 and again in 2012, investors were less rattled by the process. Stocks proved more resilient [Figure 2], even though an impasse in the 2013 debt ceiling negotiations led to a 16-day federal government shutdown.

So how about now? The U.S. federal government has already reached its prescribed debt limit and is now pursuing extraordinary measures to stretch out the timetable for the government to function normally (as it did in 2011 and 2013). The U.S. Treasury has indicated that these measures may run their course at the end of September, prompting the government to start prioritizing and delaying outgoing payments in early October.

First and foremost, as policymakers work toward resolution, we do not expect a repeat of the market decline in 2011. At the same time, we do not expect a 2013-like rally either. Still, a lot is on the line because a budget resolution for 2018 must be passed in conjunction with a debt limit increase before tax laws can be changed with a simple majority in the Senate. Otherwise, 60 votes would be required in the Senate, which is virtually impossible in this political environment. Bottom line, tax reform is an important issue for the markets, and the budget process is a potential stumbling block.

Although we expect the debt limit to be increased on time and a 2018 federal budget resolution to be reached, chances are negotiations will be tough. The unsuccessful healthcare effort highlighted Republican divisions, and conservatives’ demands could be difficult to reconcile. These risks played a role in our decision to slightly reduce equities in some of our model portfolios last week, as discussed in our latest Weekly Market Commentary. We will be watching these developments closely and will stand ready to buy a dip should one materialize.

 

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

An AAA rating is the highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has an exceptional degree of creditworthiness and can easily meet its financial commitments. Ratings agencies such as Standard & Poor’s and Fitch Ratings use AAA to indicate the highest credit quality, while Moody’s uses Aaa.

This research material has been prepared by LPL Financial LLC.

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