|To Panic or Not to Panic?|
|It’s baaaaack. The debt ceiling, that is…
You’ve likely been seeing a lot of headlines about the debt ceiling these past few days. We actually hit the ceiling back in March, but nobody seems to have noticed until recently. That’s because the president just stated that he’d force the government into a shutdown if Congress doesn’t allocate $1.6 billion to build his wall along the Mexican-U.S. border.
People are saying he’s backing himself into a corner. They’re also saying that if an agreement isn’t reached to raise the ceiling, the U.S. will default on its loans and the country will be plunged into another recession.
USC law professor Edward Kleinbard went as far as saying, “Sometime in October, the United States is likely to default on its obligation to pay its bills as they come due, having failed to raise the federal debt ceiling. This will cost the Treasury tens of billions of dollars every year for decades to come in higher interest charges and probably trigger a severe recession.”
There’s little to no chance the U.S. will default on its debts. That just doesn’t happen. The government may shut down for a bit again. The accounts may be stretched. But, in the end, we’ll pay our obligations.
But everyone wants to talk about how terrible it’ll be if Congress and the president can’t come to an agreement and extend our credit limit.Bad News Sells Papers
That’s all hype, though. I mean, it’s easier to get clicks or sell papers if you’re pushing panic. “Massive Recession Coming” gets a lot more attention than “The Market Probably Won’t React.”
But it’s the second headline that’s most accurate. Either prices drop early and recover slowly, or they don’t really drop at all. Growth will just be slower than usual.
You see, the stock market has an uncanny knack of pricing in predictable events long before they happen. And the debt ceiling debates are oh so predictable.
Pretty much all highly politicized and publicized events are already priced into stocks long before they come to fruition. It’s the things that are unpredictable — wars, natural disasters, assassinations, stuff like that — that send the market spiraling out of control. They’re often called Black Swan events. And this is not one of them.
Numbers Don’t Lie
But, if you don’t believe me, just look at the recent history of debt ceiling “crises.” Two have led to government shutdowns, but none have led to a market collapse as the fear-mongers predicted then and are predicting now.
Debt Ceiling “Crisis” of 1995
Back in 1995, during Bill Clinton’s presidency, there was a so-called crisis with the debt ceiling. It all started at the midterm elections in November of the preceding year…
We were running up against the debt ceiling and a new Republican Congress had just been elected. They were refusing to work with the president to raise debt limits to get legislation they wanted passed.
For nearly a year, the two factions battled back and forth. And finally, in November of 1995, the government shut down. It only lasted a few days, but still, it shut down. But that only gave them a little more time to argue.
By December of the same year, they still hadn’t come to an agreement, and the government shut down again. This time it lasted about three weeks.
Finally, in early January of 1996, an agreement was made, the ceiling was raised, and employees returned to work.
So, what did the market do while all this was going on? Well, it went up. Just more slowly than usual…
Between the elections and the first shutdown, the market gained an average of 0.10% a day for a total gain of 27.29%. Then, during the first shutdown, it went up a little bit more — 0.77%. In the second (longer) one, it continued to rise, albeit slowly. When the workers returned to their desks, it was up another 0.13%.
If you factor in the trading days between the two shutdowns, the market gained a total of 4.42% while it was supposed to be in a panic about the debt limit. And overall between the elections and the compromise, it rose 30.88%. Doesn’t sound like a crash to me.
That’s because the shutdown and all the debating was already priced in. You already know that up to the shutdowns, the market was going up an average of 0.10% per day. But after the compromised was reached, it started going up twice as fast — 0.22% per day. Progress slowed to account for the predictable event that was coming. But it most certainly didn’t reverse.
Debt Ceiling “Crisis” of 2011
This is the one you’re probably hearing the most about. But, interestingly, it’s the one that didn’t lead to a shutdown. Congress reached a last-minute deal and extended the ceiling so the government could make good on its obligations.
But people love to reference it because the markets were volatile in the couple of weeks the debate was going on. And they dropped a whopping 4%! It’s tough to convey sarcasm in writing, but that was some serious sarcasm.
Really? A 4% drop? That’s panic? I’m sorry to burst bubbles here, but that’s just normal. Nothing out of the ordinary. In fact, as far as corrections go, it’s tiny. Just a year earlier, in 2010, there was a 14.67% correction. People got scared. Because that’s what people do during a correction. And hey, nearly 15% is a decent drop, so I don’t blame them. But 4%? Really? That’s just a bad day.
The other reason you’ll hear about this one is because it led Standard and Poor’s, the ratings agency, to downgrade the U.S. credit rating for the first time in the country’s history. Never mind that the other two, Fitch and Moody’s, didn’t change a thing.
So, another “crisis” regarding the debt ceiling that really didn’t hurt the stock market. Just maybe some bruised egos after the ratings downgrade.
Republicans didn’t want to raise the ceiling. Democrats did. The Treasury Department started taking what it calls “extraordinary measures.” That means it started taking money from other accounts to pay the bills. With all the IOUs in the Social Security bank account, that sounds more like business as usual to me. But I digress.
From January until mid-October, D.C. debated and finally reached a compromise on October 17th. But the compromised wasn’t reached until after another mandatory government shutdown.
Non-essential workers were told to stay home from October 1st to the 17th.
And the markets were in turmoil the whole time. Just kidding — again, the markets had already priced in the stupidity of our politicians. So, between January (when we hit the debt ceiling) and the compromise in mid-October, the market went up 19.54%.
In the run-up to the shutdown, from January to the end of September, it gained 15.22% — an average daily gain of 0.08% (about the same as in the 1995 “crisis”). During the shutdown, it went up also — 2.25% to be exact. And after the compromise was reached, it accelerated to an average daily gain of 0.18% — again, a little more than double the slow growth during the debacle.
So, yet again, the market priced in a predictable event. Gains were slowed but not reversed. And once the compromise was reached, the market took off again, doubling its average daily gain.
Buy Fear, Don’t Sell It
If history is any barometer of the present and future, this latest “crisis” will prove just as meaningless as the last three. But it could present an opportunity for savvy and strong-willed investors.
Every time the crowd runs away from something, my contrarian Spidey senses start tingling.
When everyone else is afraid, it’s time for us to be daring. And when the market is running away from an asset, industry, or stock, it’s time for us to take a closer look. There may be an opportunity to turn everyone else’s fear into our profits.
So, if you see prices dipping in reaction to these fear-mongering headlines, remember, it’s already priced in and you just got yourself a deal. Thank the emotional investors and buy those dips. You’ll be very happy you did when everyone else realizes they were panicking over absolutely nothing.
To investing with integrity (and Spidey sense),