Would a Debt Ceiling Resolution Be a “Sell-the-News” Event?

Articles From: Interactive Brokers
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Chief Strategist

We’ve all heard the phrase “buy-the-rumor, sell-the-news.” If you’re an investor who hasn’t, then shame on you. Of all the various old hoary market adages, this is perhaps the most reliable. The logic is sound; if a major piece of news has been discussed sufficiently to be fully discounted by investors, then it is unlikely that any incremental positives will follow. As a result, the affected stocks can fall – even if the news is good.  

This could indeed apply to the outcome of the debt ceiling drama. On a quarter-to-date basis, equity markets moved largely sideways as the debt drama escalated, then ratcheted higher in recent sessions as signs of progress emerged. Most recently, we saw only a very modest dip on Friday when negotiations broke down, and a modest rally this morning ahead of another meeting between President Biden and Speaker McCarthy. Let’s see how it goes.

There is some real dissonance between the amount of discussion that is occurring about the effect of a potential debt crisis on equity markets and the generally blasé nature of the markets themselves. I’ve had several discussions with concerned investors, but they seem to be doing little in the way of moving into more defensive sectors or hedging with derivatives. 

A discussion that I had this morning made me a bit more concerned that a debt ceiling resolution might not be friendly for stocks.  I was privileged to be part of a discussion on Yahoo Finance with Jeanette Lowe, a policy analyst at Strategas, about the topic.  Ms. Lowe highlighted the idea that a lasting agreement would likely involve spending cuts, and reminded the viewer that markets fell after the resolution of the 2011 crisis because there were $2 trillion in cuts.  

It occurred to me that fiscal policy contraction ahead of a potential recession was sort of Keynesian economics in reverse. If we are concerned about a slowdown, then a fiscal bump would be a boon, while a fiscal cut would be an additional headwind – at least in the short-term. Remember, expansionary fiscal and monetary policy were key factors for the booming markets of 2020-21. We’ve since gone into reverse on the monetary front – a 5% rate hike and continued quantitative tightening will do that – but stocks have been overcoming that headwind this year. If a debt resolution results in tighter fiscal policies, it would create yet another hurdle for stocks and the economy.  

The headwinds would be in the short- to medium-term, at least. A more stable fiscal framework could indeed be a long-term boon for the economy, and hence stocks.  But equity markets tend to discount a few quarters at a time, not years and decades.

As with all deals, the devil is in the details. If everyone is unhappy with the deal, then it probably means that it contains reasonable compromises from both sides. But if there is no incremental good news to be gained from an agreement and the deal itself is a short-term fiscal drag, then we could easily be looking at the latest in a long series of “buy-the-rumor, sell-the-news” events.

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