Debt Ceiling Part 2: Why the Debate Continues to Matter
HWM Market Recap - May 2023
Executive Market Summary
For the past year, the stock market has gone sideways. At the beginning of May 2022, the S&P 500 Index was 4,130.61. Twelve months later, it began May 2023 at 4,166.79. Then, two days later, the index closed at 4,090.75. That is about as sideways as you can get. Naturally, there have been lots of ups and downs along the way. As we have written about in previous newsletters, we believe those fluctuations are the market’s way of working through short to intermediate-term uncertainties about the future.
These stock market zigs and zags are unsurprising given the changing economic fundamentals (e.g., rising interest rates and inflation) and political disruptions (e.g., continued war in Europe and supply chain issues) facing the world economy. For now, as things look worse, the market will go down and as things look to be improving, the market will go up.
Perhaps the most immediate and timely political puzzle to solve is raising the debt ceiling. That is, increasing the amount the federal government is legally allowed to borrow. The point being that since the federal government spends more than it collects in taxes, it must borrow money. As discussed in our February newsletter, January 19th marked the day the federal government reached its debt limit of $31.381 trillion. In addition, we noted that the government would likely not reach an agreement until the eleventh hour:
“...short to intermediate-term solutions will be found, but most likely not until the last minute or even slightly beyond the last minute. This is to say that the ‘last minute’ is not some precise moment in time but rather a moving target that goes from, let’s say, June into the fall.”
On May 1, 2023, Treasury Secretary Janet Yellen sent a letter to the Congressional leadership stating that the funds available to the Treasury Department “will be unable to continue to satisfy all of the government’s obligations” as soon as June 1st. Since January, in addition to tax receipts, the Treasury has used ‘extraordinary measures’ to meet the government’s spending obligations which are expected to be soon exhausted.
According to the U.S. Department of the Treasury:
“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.”
At this moment, what is important to understand is that we are going to hear and read a great amount of information about what is being proposed and about what agreements are acceptable. One purpose of this article is to outline the proposals that are under consideration and to suggest what will happen before an agreement is reached. The important thing for us to understand is that there could be significant financial market disruption along the way to a compromise. History shows that financial market turmoil is needed to motivate reaching an agreement.
In the meantime, both parties have dug in their heels and are waiting for the other side to blink. Forewarned is forearmed, so do not be surprised by market aggravation caused by the risk of debt default. Current circumstances have happened before. Let’s frame the terms of the debate.
Currently, the only legislation that exists to raise the debt ceiling is the Limit, Save, Grow Act of 2023, recently passed by the House of Representatives. Items in the legislation:
Raise the debt ceiling by $1.5 trillion or until March 31, 2024, whichever comes first.
Limit discretionary spending for fiscal year 2024 to the level of fiscal year 2022.
Limit the growth in discretionary spending to 1% maximum for the next decade.
Rescind unspent COVID relief funds, which will be returned to the Treasury.
Make changes to energy, regulatory, and permitting policies.
Cut the increased spending for the Internal Revenue Service.
Prevent implementation of the plan for student debt cancellation.
Impose or expand work requirements in several federal safety net programs.
The executive branch’s position is that they do not want to negotiate; they will only agree to a “clean” debt limit raise or suspension. In other words, without any conditions. The reality is that we have a divided government where legislation requires bipartisan compromise. While the politicians argue, the financial markets will endeavor to sort it all out as millions of people react to the evolving risks and seek to protect their savings and investments.
Both parties want to avoid a government default on its debt, which could lead to sustained damage to the financial markets and the economy. As long as the Treasury has funds, there is little incentive to compromise, but once the limits are reached, there is every reason to make a deal.
Defaulting on our national debt payments would be a choice made by the White House and the Treasury. This is because there are more than enough tax revenues to pay principal and interest when due. If the debt ceiling is not raised, many other payments may not be timely made. By prioritizing federal debt obligations, we will not have a default that would, in turn, impair the full faith and credit of the United States.
Some will say that the House is attaching conditions to the debt limit increase, is holding the economy hostage, and thereby threatening default. The reply is that the Limit, Save, Grow Act raises the debt ceiling. Some will say the White House is the obstacle to raising the debt ceiling because the Senate could adopt the House bill, and then the President could sign it into law, thereby raising the debt ceiling.
What makes the most sense is for the politicians to begin negotiations with the aim of arriving at a timely compromise agreement. However, the debate will likely continue to unfold until financial market turmoil forces the parties to agree.
We continue to live in an elevated-risk environment, and market volatility could increase as events unfold. There is much to be concerned about at this moment in geopolitical history; the disagreements over raising the debt ceiling are but one of many. In the meantime, we have been earning dividends and interest, with the interest earnings at levels not seen in many years. We remain cautious, and as always, we are just a phone call away.
Monthly Changes in Indices Year-to-Date Changes in Indices
S&P 500: +1.46% S&P 500: +8.59%
Dow Jones Industrial Average: +5.34% DJIA: +3.48%
Nasdaq Composite: +0.04% Nasdaq Composite: +16.82%
Monthly Performance By Sector Year-to-Date Sector Performance
Communication Services +7.20% 1. Comm Servs +25.19%
Real Estate +6.99% 2. Technology +21.46%
Financials +5.63% 3. Cons Discret +14.79%
Energy +5.41% 4. Cons Staples +4.34%
Consumer Staples +5.36% 5. Materials +4.11%
Health Care +5.06% 6. Real Estate +2.90%
Technology +4.63% 7. Industrials +2.21%
Utilities +4.55% 8. Health Care -1.39%
Consumer Discretionary +4.31% 9. Utilities -1.46%
Materials +3.57% 10. Energy -1.75%
Industrials +1.79% 11. Financials -2.56%
Monthly Top 5 Performers
Communication Services +7.20%
Communication Services jumped from the second-best-performing sector in March to the best-performing sector in April. Its leaders included: Meta Platforms Inc (+13.39%), Comcast Corp (+9.89%), Twitter Inc (+7.64%), Electronic Arts Inc (+5.67%), and Paramount Global (+4.57%).
Real Estate +6.99%
Real estate finished the month of April as the second-best-performing sector after finishing second-worst in March. Its leaders included: Ventas Inc (+10.84%), Welltower Inc (+10.50%), AvalonBay Communites Inc (+7.32%), Invitation Homes Inc (+6.85%), and Equity Residential (+5.42%).
Financials were hit hard in March following the issues in the banking industry. The sector finished the month strong as the third-best-performer with its leaders including: Brown & Brown Inc (+12.14%), Arthur J. Gallagher & Co (+8.76%), Marsh & McLennan Companies Inc (+8.54%), Aflac Inc (+8.26%), and JPMorgan Chase & Co (+6.85%).
Energy was the fourth-best-performing sector in April, with its leaders including: Hess Corp (+9.61%), EQT Corp (+9.18%), Exxon Mobil Corp (+7.92%), Pioneer Natural Resources Co (+6.52%), and Devon Energy Inc (+5.57%).
Consumer Staples +5.36%
Consumer staples has been in the top five best-performing sectors for the last three months. Its leaders in April included: Molson Coors Beverage Co (+15.09%), Mondelez International Inc (+10.04%), Church & Dwight Co Inc (+9.85%), Kimberly-Clark Corp (+7.95%), and The Hershey Co (+7.33%).
Political Events Influencing the Economy
After reporting it had lost $102 billion in deposits following the collapse of Silicon Valley Bank, authorities seized control of First Republic Bank and sold most of its assets to JP Morgan Chase. This is the second-biggest bank to fail in U.S. history, topping Silicon Valley Bank’s collapse in March. The government-brokered acquisition is the latest in a series of bigger banks swallowing failing, smaller banks. First Citizens bought SVB, New York Community Bank bought Signature Bank, and UBS bought Credit Suisse. Check out our newsletter from last month, where we discuss what happened with Silicon Valley Bank’s collapse.
In a 102-page report, the Federal Reserve analyzed the collapse of Silicon Valley Bank, citing its inadequate supervision and the bank’s failure to manage risks and fix vulnerabilities. Also, in an accompanying letter, the Fed’s Vice Chair for Supervision called for stricter rules and more supervision to be applied to financial institutions.
Minutes from the Federal Reserve’s March 21-22 meeting showed that policymakers considered pausing rate hikes due to the issues in the banking industry but ultimately determined that because of high inflation and the tight labor market, they would raise interest rates by 0.25% (25 basis points) despite the likelihood of a recession. The minutes also indicated that the banking industry fallout would send the economy “into a mild recession starting later this year, with a recovery over the subsequent two years.”
The Consumer Price Index (CPI) rose 0.1% month-over-month and increased 5% in March from a year ago, down from the 6% year-over-year increase in February. This is the smallest gain for the CPI since May 2021. Core CPI, which excludes food and energy prices, increased by 0.4% in March and was up 5.6% from a year ago.
March was the 13th time in the last 14 months that home sales fell. U.S. existing-home sales decreased by 2.4% in March from February and lost 22% year-over-year. In addition, the national median price for an existing home declined by 0.9% in March from a year ago to $375,700, the largest annual decrease since January 2012. This marks the second consecutive month where prices have fallen annually, the first time in eleven years.
The average rate for a 30-year fixed mortgage sits at 6.43%, up from 6.32% at the end of March and up 1.33% from a year ago.
A new report from Redfin found that some Gen Zers took advantage of low mortgage rates before interest rates increased, putting them on a better homeownership trajectory than other generations. About 30% of 25-year-olds owned their homes in 2022—which is higher than the 27% of Gen Xers and 28% of millennials when they were the same age and a little lower than the 32% rate for baby boomers. Gen Zer homebuyers were most prevalent in Virginia Beach, VA, accounting for 9% of all home purchases last year. The 2022 median sale price for a Gen Z buyer in the area was $255,000.
U.S. rents fell 0.4% year-over-year in March to $1,937. This marks the first annual decrease since the pandemic was declared in March 2020 and is the lowest median asking rent in 13 months. Austin, TX and Chicago, IL saw the largest declines in rent over the last year, -11% and -9.2%, respectively. Raleigh, NC and Cleveland, OH had the most aggressive gains, +16.6% and 15.3%, respectively.
According to the Financial Times, companies have committed to invest more than $200 billion in U.S. manufacturing projects since the government passed the Inflation Reduction Act and the CHIPS Act. The investments in clean technology and semiconductors are almost double the commitments made to those sectors in 2021 and nearly twenty times those in 2019.
As WalletHub’s 2023 Credit Card Landscape Report reported, the average interest rate on new credit card offers in Q1 was 22.15%, up from 18.32% a year ago. Business credit cards saw the highest increase in interest rates, rising by 24.75% year-over-year. At 20.92%, the overall average credit card is the highest since the Federal Reserve began tracking this measure in 1994.
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About the Author
Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and virtually nationwide with the financial decision-making process to organize, grow, and protect your assets.
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