As we approach the end of May and beginning of June, we are getting ever closer to what has been referred to as the “X-Date.” What is the X-Date, you ask? That is the day where it is projected that the government will no longer be able to pay its bills.
June 1st is the widely anticipated date. There is some uncertainty as to the exact date as there is difficulty in projecting annual tax payments and refunds and the government may be able to find enough change in between the couch cushions to push the X-Date back a month or so.
Regardless, being that the topic of the debt ceiling is now front and center of the nation’s collective mind, let’s look at what exactly the debt ceiling is, how we got here, the potential consequences of a government default and what it may all mean for those that invest in the capital markets.
What is the debt ceiling?
The debt limit, or debt ceiling, is the limit on the amount of debt The US Treasury can have outstanding to pay for the government’s bills. It references current and past expenses that have already been approved. It is not an authorization for future spending. The reason why the issue is so salient right now is that we are approaching the limit of the debt ceiling. If Congress does not increase the debt limit, the US could default on its debts and obligations. This would be unprecedented and could have serious economic consequences across the globe.
Despite all the political theatre surrounding this topic, the debt ceiling is something that was increased in the past with relatively little fanfare and virtually no media coverage. Here are some items to keep in mind as this emotionally charged issue continues to unfold:
- According to the Treasury Department, Congress has increased or suspended the debt limit 78 times since 1960; the number rises to over 100 since the debt ceiling was created in 1917 to help fund World War I
- The US has never failed to make its debt payments
- In the past, votes to increase the debt limit were quiet (and, as mentioned above, common). That all changed in 2011 when the country came quite close to default.
- Congress eventually reached a deal to increase the debt ceiling
- However, not before US debt was downgraded by Standard & Poor’s
- Congress eventually reached a deal to increase the debt ceiling
The following chart will help to provide some perspective on the debt ceiling and the stock market since 1970:
Applying some perspective
If something like 2011 happens in 2023, it could cause some damage to the economy, and there would likely be increased volatility in the financial markets. That said, we believe the damage would likely be short-lived.
Initially, the government would likely stop paying federal workers. Next, the government might delay payments to those who receive direct payments from the government, such as Social Security recipients. All these impacts though tend to be short-term. That is, once funding is restored, the government will fulfill all its obligations.
Therefore, the reality of the situation is that there may be a short period of time where a select group of people are adversely impacted by the situation but quickly made whole. In other words, the overall impact to the economy will be relatively modest. Chief Investment Officer at US Bank, Eric Freedman put it well when he said, “this looks to be more of a short-term issue. There’s nothing specifically we as investors can do to prepare for what’s ahead as this issue plays out.”
Now that we are nearing the end of May and still awaiting a solution, anxiety is heightened. The only real solutions, at this point, appear to be either the debt ceiling being increased or suspended through a bi-partisan vote. Equity market volatility should, in theory, be increasing as we approach the X-Date. Further, the dollar and Treasury bills could be determined to be more risky and lose value. This does not necessarily need to occur, though, as the dollar and Treasuries have long been considered safe haven assets.
All this uncertainty is leading many investors to consider moving to the sidelines while they “wait for things to stabilize.” To these investors, we would like to point out that this situation will eventually be resolved. When that happens, the stock market will likely rebound. An investor that sells now and buys back in at a later date, does not give him or herself very much margin for error. How likely is it that one would be able to sell high and buy low in this very uncertain scenario? We do not believe the odds are favorable.
As we all know, the political agenda tends to capture significant headlines from time-to-time. From our vantage point, as capital allocators, the broad political landscape is just one factor to consider as we attempt to optimally allocate our clients’ portfolios to help them reach their long-term goals. When one thinks about the fallout from the 2011 debt crisis and the resulting credit downgrade, there were no significant long-term consequences, despite what, at the time, felt like a never-ending economic, political and market drama.
Though our collective faith in politicians is at or near an all-time low, we have to give them the benefit of the doubt that they will not recklessly push the country into a recession or an unnecessary fiscal crisis. In all likelihood, they will figure out a solution that provides relief to their constituents so they can boast about everything they fought for and accomplished while saving the country from financial disaster. Who knows, political leaders may even have to…gulp…compromise!
As the saying goes, “history does not repeat but it does rhyme.” We’d caution investors from making any rash moves in order to “wait until things stabilize” or to “avoid a collapse.” Markets are forward looking mechanisms and assuming you can time things perfectly is typically hazardous to your wealth. Rather, allow the natural compounding of earnings and interest to do the work for you and take advantage of the various market opportunities that present themselves along the way. Remember, volatility is the toll we investors pay for long-term returns above inflation. Allow volatility to work in your favor by staying invested in a durable portfolio that aligns with your risk tolerance. As we can see from the earlier chart, time in the market is much more important than timing the market.
Chief Investment Officer
About Wolf Group Capital Advisors
At Wolf Group Capital Advisors, a comprehensive wealth management firm and Registered Investment Advisor (RIA) based in Fairfax, VA, nothing is more important than the fiduciary responsibility we have in managing your wealth. Taking the utmost care, we focus on providing advice tailored to your specific circumstances. With more than two decades advising U.S. expatriates and non-US citizens employed by international organizations, we are qualified in investment strategies addressing global issues. Empathy and curiosity—combined with our experience in life planning and investment management—enable you to explore a wider set of possibilities that can lead to a fulfilling life you’ve worked hard to attain.
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