Another debt ceiling debate could further hurt stocks
— -- Q: Stocks suffered late last summer as the debt ceiling drama raged on. Does another disagreement about the U.S.' level of debt threaten the market again this year?
A: The debt ceiling debate wreaked absolute havoc on the stock market last year. And that wasn't even an election year.
There are few topics that stoke political tension as well as the debt ceiling does. The debt ceiling, a mandated limit on how much the U.S. may borrow, gets at the very root of what is dividing the nation politically and economically.
On one side are those who say that the U.S. should be tightening its belt and drastically cutting spending to prevent the debt load from piling up. On the other side are those who think that government spending is the force that can help accelerate economic activity and generate future growth.
The debate of austerity vs. government spending is beyond the scope of this column. Readers who would like to debate this are welcome to do so in the comments section below.
But in this column, investors can learn how markets are likely to react when the topic comes up again. And it's looking like it's going to be a battle royale.
House Speaker John Boehner in May 2012 made public comments that he plans to delay an increase in raising the debt ceiling until major spending cuts are made. Already, trillions of spending cuts and tax increases are scheduled to kick in next year. And some politicians will be looking for more before Congress gives its blessing for the U.S. to increase its borrowing limits.
When the debate of the debt ceiling returns, it's likely to be an ugly battle. When this skirmish starts is a big unknown. Based on some estimates, the U.S. government may be able to operate under the existing debt ceiling until early 2013. Congress raised the limit already to $15.2 trillion as a result of a controversial last-minute deal on July 31. That means investors might have some breathing room before the matter becomes a problem.
If recent history is a guide, though, the debt ceiling debate might be a real downer for the market when it actually hits. The last time this happened, last summer, set up markets for a major downdraft. The Standard & Poor's 500 index had already fallen nearly 6% from its 2011 high at the time the debt ceiling was raised.
But things got much uglier after Standard & Poor's cut the U.S.' AAA credit rating on August 5, 2011. That downgrade, and the resulting fear it caused, wound up helping to push stocks down nearly 20% from the year's high, threatening to spark a bear market.
Could the same type of drama happen again if there's another debt ceiling debate? Absolutely. It's tempting to think investors would be better at handicapping the situation this time around, after all, the crisis in 2011 created a huge buying opportunity for investors. But when the financial wherewithal of the U.S. government is threatened, it's hard for investors to ignore that.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz
