Are You Selling Stocks Prior to the Aug 2 Debt Limit Expiry?

by Darwin on July 24, 2011

Around the office, some of my co-workers are talking about how they just unloaded all their stock holdings and shifted into cash or bonds because of the impending Aug. 2 deadline to extend the debt limit.  To do otherwise, assuming the government is unable to “prioritize” payments to bondholders (which would entail curtailing payments otherwise obligated) would constitute a default by ratings agencies (Greece just defaulted, see my thoughts on the Greek Debt Situation).  The mainstream media, politicians and many economists have stated that if this were to occur, it would be akin to Financial Armgeggedon, worse than if we hadn’t bailed out financial institutions in 2008-2009.

I don’t know what the actual outcome would be if the US did default, other than some temporary chaos at a minimum and further threats of countries dropping the US Dollar as their reserve currency, but I do believe in efficient markets and I think the market has already discounted the actual outcome.  The market is constantly adjusting to information in real-time and by selling off all your stock holdings now, you might end up missing out on a huge up day.  Just look what happened earlier this week when it emerged that the “Gang of Six” had presented a reasonable and actionable plan to both reduce the deficit and extend the debt limit.  Stocks rallied 2% that day on the news.  Imagine if you had withdrawn all your holdings just prior!

Are Bonds and Cash Really Safe?

Here’s the ironic part about people shifting their holdings to bonds and cash.  For one, if the US defaults, we can’t necessarily call ourselves the only “risk-free” investment anymore, right?  After all, with a default, you’d think bonds would actually tank – since those interest payments will have ceased!  So, some people that shifted six figures into that “safe haven” may actually take more of a haircut than stocks!  Next, “cash” is usually a money market fund or equivalent in investment plans.  Well, many financial experts actually predict that in the event of a US default, money markets would actually “break the buck” and funds would decline in value as well, similar to what we saw occur during the financial crisis (Financial firms actually backstopped these losses with their own funds, but that’s not guaranteed, nor are they obligated to do so).

Finally, let’s say you DID shift all your funds into bonds and cash and Congress does strike a long-term deal to extend the debt limit.  This might be inflationary in nature, right?  After all, all we’re doing is kicking the can down the road and chances are, some sort of interim debt limit increase will be passed, but the actual savings projected may never materialize (health care reform anyone?).  So, bonds and cash will get killed by inflation while stocks will continue to happily march upward as earnings and dividend increases continue to advance, actually helped by inflation.

My advice isn’t to go buy a ton of stock or run for the hills.  Whatever your asset classes correlation is in your total portfolio, if there is a default, virtually everything’s going to go haywire – and then return to normalcy eventually, as it always have.  But in selling now or buying now, you may have timed it horribly.

I suggest you do nothing.  Stick to your long-term investment strategy…Because the market has already discounted the risk and the outcome appropriately and to do otherwise is a pure gamble.

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1 Kathryn C July 25, 2011 at 2:50 pm

I dated a guy who said that his wealth manager was calling him off the hook one day when stocks were selling off, to see if he wanted to sell. I told him to fire his “wealth manager.” Even for people in their 20’s, 30’s and 40’s, it’s shocking how many have such a short term mentality.

Needless to say it didn’t work out with me and the guy, I wonder why?? ah ha ha!

Totally agree with your suggestion.

2 Monevator July 29, 2011 at 11:42 pm

This is the first time I’ve been really worried about being so long equities in well over two years (yes, everyone now says that but I’m on record – link below! 😉 ) yet in the end I reached the same conclusion as you.

My portfolio is heavily de-indexed at this point and value-tilted, and low beta versus the market. My assumption is if we have a heavy fall, I’ll convert a lot of it back into market-tracking ETFs.

But anyway, yes, I’m nervous. I think the unintended consequences of the US losing AAA status could be mind-blowing, a damp squib, or anything in between, as I’m about to blog today. My worries are all today with legal technicalities, rather than whether the US’ children can pay their debts in 30 years, etc.

(Historical record:

3 Arvin J July 30, 2011 at 1:08 am

Not normally what I desire to read about, nevertheless it was absolutely price my time. Thanks.

4 Super Saver July 30, 2011 at 6:20 pm

I think the market has priced in the debt ceiling crisis being a non-event. If something happens otherwise, e.g. China starts mass selling U.S. treasuries, the market will fall.

At this point, I think there is signficant downside risk and no upside potential. I’m mostly in cash, except for company stock options that I still own.

If I’m wrong, I can easily get back into the market as a relatively good price.

5 Super Saver August 7, 2011 at 9:59 am

The tougher question now is whether to ride the market down (as in 08/09). I still have not recovered all the losses from that time frame.

Having the painful experienc of holding in 08/09, I decided to sell in June 2011. The situation with the debt crisis seemed a lot like the passing of the TARP, markets fell after the solution passed.

I think the Dow will fall to at least 10,200. Confidence in the Fed and the Obama administration is extremely low. I’ll re-evaluate the situation at 10,200. Who knows, the situation may change, for better (hopefully) or for worse (probably).

6 Canada Goose August 17, 2011 at 2:57 am

Usually not what I want to read, but the price is definitely my time. Thank you.

7 Moncler October 22, 2011 at 3:23 am

i love you.

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