The August 2nd deadline for political agreement on the U.S. debt ceiling is approaching. Although this ceiling increase issue (which has been quietly done many times in the past) has been overly magnified by the politicians, the issue of ongoing U.S. budget deficits and resultant debt is real and very significant. The debt ceiling is a sideshow (we feel strongly it will be raised by the deadline); the real issue- can a budget deal show enough credible action to satisfy the credit rating agencies?
This issue has become a focal point for debate on how large government should be and what type of tax system should pay for that government. Many plans have been presented. Ultimately we view the debate as healthy, although we question whether or not the biggest issues can be resolved without ongoing national debate and the presidential election of 2012. The credit rating agencies have determined they need to see significant progress toward agreement on how to control our budget deficits or they may downgrade U.S. debt from its longtime AAA credit rating.
Our view: although we think it is a small possibility, a cut in the AAA credit rating of U.S. debt is a big deal and would raise the cost of funds for our government, business owners, students and consumers alike. We think it makes sense for investors to keep bond maturities short and quality high on a significant portion of their fixed income investing. Equity investors should maintain their core portfolio positions but be aware that a policy mistake in this environment could create an opportunity to buy stocks at a discount.