August 3, 2011

How Surprising is it that the Dow Dropped After the Debt Ceiling Deal?

Carroll Andrew Morse

I saw a headline from a CNN newscast from last evening that read "Dow Drops Despite Debt Deal". With the disclaimer that you don't want to attribute too much significance to a single day's movement in the stock market, I don’t see the drop as paradoxical or even random.

The first chapter of any book on technical finance will tell you that stocks and bonds move in opposite directions. When "the market" feels investment opportunities in businesses are likely to pay off, money moves towards stocks and away from the assumed safety of bonds; when "the market" feels there are fewer good business investment opportunities, money moves towards bonds.

The down-to-the-wire debt ceiling negotiations jumbled the traditional logic and created a perception that bonds weren't as safe as usual. The eventual deal mitigated the worries.

So, if I may borrow Justin's juxtaposition from a previous post, it would not be surprising if a restoration of confidence in the ability of the Federal government to make its debt payments on time led “the markets” to wager that investing in the government's ability to tax is once again a better bet than actual investment in productive enterprise.

Who says that markets are rational all of the time!

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If we don't do the debt ceiling deal, the stock market will tank.

If we do the debt ceiling deal, the stock market will tank.

Can we undo the debt ceiling deal?

Posted by: Patrick at August 3, 2011 2:53 PM

There were already other market forces in play that began the downward spiral of the indexes. Both the July jobs report and ISM weren't exactly a bright spot. The debt ceiling merely fanned the flames. Even with a slightly unexpected uptick in the ADAP jobs report, lay-offs have risen. In reality, the market, despite it's downward trend, did pretty well considering the flight to gold due to the 'debt crisis.' It seemed like investors weren't worried as much about a deal getting done as they were other factors.

Posted by: Max Diesel at August 3, 2011 3:27 PM

While it is true that daily stock market movements are mostly noise and contain little meaningful information, one cuold also hypothesize that the market is disappointed at the terms of the debt ceiling deal, which contains no genuine spending cuts at all, and at the cave-in by Republicans on undoing the Bush tax rates in 2013. (And we wonder why they handled that in such a tacit way...) After all the posturing, the deal is just another "kick the can" exercise by big-government politicians. This has bad implications for the economy and for future tax rates.

The stock/bond market dichotomy is too simplistic. A lot of new money went into gold this week as well - if you are bearish on the economy and have no confidence in the value of the currency, the gold standard is the Third Way.

Posted by: BobN at August 3, 2011 5:19 PM

Throw in the fact that this is a global marketplace. Other countries are losing confidence in the USA (Hussein Obama's plan) as a world leader. Witness the China downgrade and flight to gold.

Posted by: ANTHONY at August 3, 2011 11:16 PM

Didn't China announce they would start buying European PIGS debt? Shouldn't that be a red flag for the US?

Posted by: Max Diesel at August 4, 2011 9:58 AM

A couple of things. Markets seek certainty, I don't see where the debt deal delivered that.

As far as surveys of public opinion, the debt deal doesn't effect the guy on the street in any way he can measure. If he had unemployment uncertainty, there is nothing there to re-assure him. If his home value was falling, there was no direct effect from the deal.

Posted by: Warrington Faust at August 4, 2011 12:26 PM
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