Hope you are all doing well. I have noticed from speaking with a lot of you this week that there is a considerable amount of concern about the stock market and the economy. Many of the issues that face us now are not new, so it is good to look to the past and see what has happened when similar events have occured. We don’t have to go back too far, only to 2011 to find a similar fact pattern as to what is going on this year. Keeping with the 2011 theme I will break down the similarities using lyrics from 2011’s #1 single, Adele’s Rolling in the Deep.
Reaching a fever pitch and it's bringing me out the dark— Adele
Since the government shutdown ten years ago the debt Ceiling has not been a major area of concern. The issue lay dormant but not solved, and it appears poised to become an issue again like it was in 2011. The United States hit the debt ceiling on January 19th. The crisis is still likely five to six months away. Many of you have voiced a similar concern about when and whether a deeply divided Congress will be able to find a path to raising the debt ceiling. The news this week is that Treasury Secretary Janet Yellen began employing “extraordinary measures” to help delay the point at which the nation might default on its obligations. Extraordinary measures are something the Treasury has employed more than a dozen times in debt ceiling battles dating back to the mid-1990s. They encompass a variety of actions. If you’re a federal employee you may remember that among the measures the Treasury has taken in the past includes steps like suspending new investments in various retirement plans for government employees. From a market perspective, politics generate headlines but it tends to be just noise and not to be a long-term driver of market performance. There have been several instances of significant debt-ceiling showdowns, with 2011 being the most notable because the rating agency, S&P downgraded the U.S. credit rating. In all of the major debt ceiling showdowns, markets were higher in the 12-month period after the debt ceiling was resolved (see chart below). The 2011 debt situation is illustrative because the political configuration in Washington was exactly the same as we have today: a Democrat in the White House, Democrats holding a slim majority in the Senate and Republicans holding the majority in the House of Representatives. Summer of 2011 was the closest the United States has ever come to defaulting. Markets were roiled as uncertainty about when Congress would raise the ceiling continued through the summer. The S&P 500 fell by more than 16% in just over five weeks in July and early August of that year. Standard & Poor’s downgraded the U.S. credit rating for the first time ever. Congress eventually reached a compromise in early August 2011, raising the debt limit just days before the country would have defaulted. So looking at that scenario should you sell your stocks? Historically the stock market has not traded on the debt ceiling until we are much closer to the default deadline. Selling now in anticipation of danger that likely will not happen and is still months away from being a legitimate concern is not the right call. The market in 2011 closed positive for the year, and even with the debt ceiling lurking the S&P continued to rise, peaking for the year in April. Market performance tends to be driven more by economic and earnings fundamentals, things like the Fed meeting or tech companies earnings rather than politics.
|Market performance based on S&P 500 Index performance|
|Event||Dates||Performance, During Standoff||Performance, 1 month after||Performance, 12 months after||Notes|
|1995 Debt Ceiling Standoff||Oct 1995 – Mar 1996||10.0%||1.3%||19.9%||Two periods of government shutdowns (5 and 21 days)|
|2011 Debt Ceiling Standoff||May 2011 – Aug 2011||(5.2%)||(6.9%)||10.4%||S&P downgrades U.S. credit rating from AAA to AA+|
|2013 Debt Ceiling Standoff||May 2013 – Oct 2013||3.2%||4.5%||8.2%||Government shutdown for 16 days|
Source: Bloomberg, past performance is not a guarantee of future returns
Turn my sorrow into treasured gold.— Adele
Most peoples largest asset is their home. New housing data released this week showed home prices are falling. Home-sale prices fell year over year in 18 of the 50 most populous U.S. metros during the four weeks ending January 15. Prices fell 10.1% year over year in San Francisco, 5.5% in Austin, 2.5% in Chicago, 2.4% in Los Angeles, and 2.2% in Boston. They fell less than 2% in Portland, OR and New York City. Again 2011 can be a guide. Home prices bottomed in the spring of 2011. The current housing recession is unlikely to rival what we experienced from 2009-2011. People have jobs and savings and are paying their mortgages. Serious delinquencies (mortgages at least 90 days past due) are hovering below 0.4%. By comparison, 7.9% of all mortgages were seriously delinquent at the end of the second quarter of 2011. You can also see from the disparity between the cities listed above that as the saying goes “all real estate is local”. For example, as of the middle of 2011, prices had fallen by 59 percent from their peak in Las Vegas, while they had fallen by less than 10 percent in Denver. Right now San Francisco is the worst performing real estate market while not too far north Portland is performing OK. A housing recession may impact consumer sentiment as the wealth of homeowner’s takes a hit. Historically, it has little effect on the stock market. In fact, that sorrow in the housing market in some cases has coincided with significant rallies in the stock market. That is because the markets are a forward indicator for example moving when the Fed begins raising rates whereas home prices tend to lag, feeling the impact months after the rate hikes or in the case of 2011, the sub prime crisis. Indeed the S&P 500 rose 50.25% while home prices fell from 2009-2011.
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