May 6th, 2023: Taking a balanced approach to the debt ceiling drama I’ve had quite a few conversations with clients regarding the uncertainty surrounding the debt ceiling situation. The U.S. government has dealt with debt ceiling issues in the past, with varying degrees of success. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. The debt ceiling limits how much money the federal government can borrow to pay its bills. As we have seen in recent news, it has become a significant point of contention in Washington. It’s more concerning that the government spends more than it takes in and that issue is ongoing.
The political grandstanding is frustrating. Considering the extreme polarization in Washington, any outcome is possible this time. It’s important to remember that predicting the market’s next move can be challenging. It sometimes behaves counter-intuitively. As strange as it may sound, the market could fall initially due to a shutdown and then rally in anticipation of reopening. This is similar to what we witnessed during the economic shutdown in 2020. If the deadline was missed, I would expect there would be an initial market shock and then at some point that the market would rally when the narrative changed that the debt ceiling would eventually be raised.
Personally, I’m more concerned about the stress being placed on the banking system due to the massive amount of money flowing out of banks and into money markets. Eventually, the Fed may be forced to cut rates to bail out the bankers who have mismanaged their assets and liabilities. The significant capital losses in bank stocks might seem like a buying opportunity; however, the difficulty lies in the fact that stock prices can plummet to zero overnight. We have seen a few banks taken over by regulators at the first sign of trouble. In financial stocks there are no “meme” rallies rescuing banks on the brink of bankruptcy. That only works when the regulators don’t get involved and capital can be raised by issuing new shares. The discount in bank stocks is warranted due to the risks associated with customers moving money to safer banks. Banks that have managed their portfolios well haven’t experienced much of drop in value. Those that are down the most offer potential returns of plus 50% if they don’t get taken over by regulators, but there’s also the risk of their stocks going to zero.
Investors are now paying a premium for companies with consistent earnings and revenue. We have learned that companies can rally if they aren’t experiencing revenue growth as long as they don’t lose money. The businesses that are buying back stock and/or cut expenses have done the best. On the other hand, companies with substantial debt or an inability to buy back stock haven’t fared as well.
In light of the current environment, I’ve been managing your investment portfolio with diversification and risk management in mind. This balanced approach allows your investments to withstand economic storms like the one we’re currently facing. While it’s natural to feel concerned due to bank failures and the potential government shutdown, I have confidence that taking a long-term view and not focusing on the day-to-day moves of 1%-2% is the best way to navigate market fluctuations. The real risks regarding the deficit will play out over time in the form of higher inflation and interest rates. The government will try to slowly inflate their way out of this problem. The likely outcome is that politicians will continue to kick the can down the road. Unfortunately, there isn’t going to be quick fix to this deficit problem. The focus continues to be on the long-term success and resilience of the businesses we are invested in. This approach will help us remain proactive in the face of these uncertain economic times.
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I’ve had quite a few conversations with clients regarding the uncertainty surrounding the debt ceiling situation. The U.S. government has dealt with debt ceiling issues in the past, with varying degrees of success. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. The debt ceiling limits how much money the federal government can borrow to pay its bills. As we have seen in recent news, it has become a significant point of contention in Washington. It’s more concerning that the government spends more than it takes in and that issue is ongoing.
The political grandstanding is frustrating. Considering the extreme polarization in Washington, any outcome is possible this time. It’s important to remember that predicting the market’s next move can be challenging. It sometimes behaves counter-intuitively. As strange as it may sound, the market could fall initially due to a shutdown and then rally in anticipation of reopening. This is similar to what we witnessed during the economic shutdown in 2020. If the deadline was missed, I would expect there would be an initial market shock and then at some point that the market would rally when the narrative changed that the debt ceiling would eventually be raised.
Personally, I’m more concerned about the stress being placed on the banking system due to the massive amount of money flowing out of banks and into money markets. Eventually, the Fed may be forced to cut rates to bail out the bankers who have mismanaged their assets and liabilities. The significant capital losses in bank stocks might seem like a buying opportunity; however, the difficulty lies in the fact that stock prices can plummet to zero overnight. We have seen a few banks taken over by regulators at the first sign of trouble. In financial stocks there are no “meme” rallies rescuing banks on the brink of bankruptcy. That only works when the regulators don’t get involved and capital can be raised by issuing new shares. The discount in bank stocks is warranted due to the risks associated with customers moving money to safer banks. Banks that have managed their portfolios well haven’t experienced much of drop in value. Those that are down the most offer potential returns of plus 50% if they don’t get taken over by regulators, but there’s also the risk of their stocks going to zero.
Investors are now paying a premium for companies with consistent earnings and revenue. We have learned that companies can rally if they aren’t experiencing revenue growth as long as they don’t lose money. The businesses that are buying back stock and/or cut expenses have done the best. On the other hand, companies with substantial debt or an inability to buy back stock haven’t fared as well.
In light of the current environment, I’ve been managing your investment portfolio with diversification and risk management in mind. This balanced approach allows your investments to withstand economic storms like the one we’re currently facing. While it’s natural to feel concerned due to bank failures and the potential government shutdown, I have confidence that taking a long-term view and not focusing on the day-to-day moves of 1%-2% is the best way to navigate market fluctuations. The real risks regarding the deficit will play out over time in the form of higher inflation and interest rates. The government will try to slowly inflate their way out of this problem. The likely outcome is that politicians will continue to kick the can down the road. Unfortunately, there isn’t going to be quick fix to this deficit problem. The focus continues to be on the long-term success and resilience of the businesses we are invested in. This approach will help us remain proactive in the face of these uncertain economic times.