There’s been a lot of discussion in the news lately about the level of indebtedness south of the border, specifically around the legislative limit on the amount of national debt that can be issued by the U.S. Department of the Treasury. Colloquially known as the debt ceiling, this limit is imposed upon the Treasury by the U.S. Congress. The debt ceiling has been raised and suspended many times throughout history to allow the U.S. Government to meet its financial obligations. The Congress has raised the debt ceiling 78 times since 1960, 49 times under Republican administrations, and 29 times under Democratic administrations. There have been only two previous incidents where the debate over raising the debt ceiling has led to a genuine concern.

The most important takeaway whenever you hear about this topic in the news is that discussions around the debt ceiling tend to be uneventful, and it's just one of many bargaining chips used by politicians on either side of the aisle to extract something from the current administration.

The most significant of these two events occurred in 2011, when the U.S. came close to defaulting on its debt for the first time in history. It’s important to note that this default would have been wholly self-inflicted. Subsequently, Standard and Poor's downgraded the credit rating of the U.S. Government from AAA to AA+. The other event took place in 2013 and led to a partial shutdown of the U.S. Government from October 1st to October 17th of that year. In both of these instances, equity markets reacted with increased volatility. Uncertainty around a government's ability to pay its debt can lead to short-term selloffs in equities, since it can have widespread implications across the economy. However, these selloffs have historically been followed by recoveries once the debt ceiling has been raised. As shown below, during 2011, the S&P 500 (represented by the SPY S&P 500 ETF) dropped by 12.6%, before bouncing back by 22.06% in the 6 months following the initial selloff.

All returns expressed in the table above are percentages, and denominated in USD. Source: Morningstar Direct

How much each sector is impacted can vary depending on the economic environment during any crisis. Traditionally, defensive sectors that have more inelastic demand such as utilities, healthcare, and consumer staples have performed better during periods of uncertainty. Conversely, sectors that are more reliant on positive economic sentiment such as financials and consumer discretionary face greater challenges in uncertain times. For example, during the 2011 selloff, industrial, material and financial sectors experienced the largest declines. With that in mind, it's also possible that financial markets don't pay as much attention to a political or economic crisis as people may expect. During the 2013 U.S. Government shutdown, we didn't observe any kind of broad selloff.

All returns expressed in the table above are percentages, and denominated in USD. Source: Morningstar Direct

Although games of political brinksmanship may prove to be a high emotion topic for the media to cover, it's likely that the risk is overblown and being sensationalized. Using historical precedent as our guide, it becomes apparent that the recurring debt ceiling debates are often political theatre, making them largely inconsequential for more astute long-term investors. We’ll be watching how these talks progress, and making adjustments within portfolios if necessary.