Big Stock Market Move on Monday?

It appears that the House, Senate, and White House are very close to a compromise deal on raising the debt limit. What will this mean for the markets on Monday? I have some thoughts for your consideration.

This week the big U.S. market indexes (Dow, S&P, and NASDAQ) each dropped by approximately 4% from their recent highs on July 22. On the other hand, I was relieved to see that our retirement portfolio lost less than 1% during this same period. This means that our portfolio is now outperforming each of the major indexes year to date.

Why did the markets drop this week? This is the “logic” that I observe:

1.  Your average investor has been reading and hearing non-stop in recent weeks that failing to reach an agreement on the debt ceiling would be “bad.”

2.  The average investor believes that when things are “bad”, the markets should drop. They don’t know why that should be the case. They just automatically associate bad news with a market decline.

3.  Because investors are being told that things may go “bad” very soon, many of these investors have been selling so that their investments won’t get devalued by the “badness.”

4.  Thus, a general fear of unspecified economic badness associated with a failure to timely raise the debt limit has caused a market decline before anything bad has actually happened.

Make sense?

What’s also interesting to me is that I can detect no real consensus among the “experts” as to how or why a failure to raise the debt limit will be bad for the markets. There is some concern that the U.S. government credit rating will decline, causing an increase in interest rates. I get that.

But – that doesn’t sound particularly bad to me, a dedicated retirement saver. We have very little debt and all of it is at a fixed interest rate. If the banks raise interest rates on savings and CDs, I’m all for that.

Long and medium term bond funds could take a hit but that is always a concern with interest rates so low now. Instead of owning bond funds, buy individual bonds that you can hold until maturity. That way you don’t have to worry about price fluctuations on the secondary bond market. Buy TIPS and I-Bonds and get inflation protection as well.

So, back to Monday. I think a lot of the “badness” is now priced into the market as fear. When the news is announced tomorrow night that a deal has been reached (perhaps to be technically concluded by legislative action on Monday), I expect the markets to rebound positively. If you left the market last week like some did (we did not) you may miss a nice uptick.

That’s my theory anyway. Anyone have any different thoughts?

FREE UPDATES: If you enjoy what you read here, please consider subscribing to receive free updates automatically by RSS feed or by email. (I promise that your email address will not be shared or used for any other purpose.)