January 4, 2013

The markets powered higher on the first trading day of the year after the limited agreement on taxes and the two-month postponement of sequestration.

And the headlines for the TSP suggested the stock funds especially had a banner year in 2012. Coming on a day when the TSP stock funds shot up 2.5%, it is tempting to think that as savers and investors, we’re out of the woods. It just might be a good year afterall….

But recent past experience in the aftermath of the 2011 debt ceiling talks suggests more uncertainty lies in the months ahead, with a possible negative reaction if (when?) talks go to the brink of default.

In 2011, the TSP stock funds traded sideways as the debt ceiling discussions took place from mid-May to early August, but then fell precipitously after the major debt rating agency Standard & Poor’s downgraded U.S. debt from AAA to AA+. The C Fund fell from a high of $16.43 in late July to $13.68 on August 8th – days after the downgrade by S&P. The S Fund fell from $23.19 in late July to $20.07 on August 8th and then to $18.24 two weeks later, which was a 20% drop from its highs earlier in the year. The I Fund dropped from $21.18 in late July to $17.53 on August 8th. It then fell to $16.41 later in September, which represented a drop of 20% from its highs earlier in the year.

The stock funds slowly recovered, and indeed they enjoyed double-digit gains in 2012. But the experience of the past few weeks suggests that we will return to the May-August 2011 gridlock in debt ceiling and other fiscal discussions, with potential further downgrades by debt rating agencies. This would again most likely impact the TSP stock funds negatively.

Indeed another major debt rating agency, Moody’s, issued such a warning on January 2nd, immediately after the current agreement was announced. It stated in a press release:

“[T]he fiscal package passed by both houses of Congress yesterday is a further step in clarifying the medium-term deficit and debt trajectory of the federal government. It does not, however, provide a basis for a meaningful improvement in the government’s debt ratios over the medium term. The rating agency [Moody’s] expects that further fiscal measures are likely to be taken in coming months that would result in lower future budget deficits, which are necessary if the negative outlook on the government’s bond rating is to be returned to stable. On the other hand, lack of further deficit reduction measures could affect the rating negatively. Notably, yesterday’s package does not address the federal government’s statutory debt limit, which was reached on December 31.”

Moody’s concluded that it “will need to consider these measures in assessing the rating outlook…The debt trajectory resulting from this process is likely to determine whether the Aaa rating is returned to a stable outlook or downgraded to Aa1, as Moody’s stated last September.”

Should Moody’s follow S&P’s lead and downgrade U.S. government debt, we can expect further declines in stock markets and the TSP stock funds, as in August-September 2011.

Yet declines in the TSP stock funds present unique opportunities. Read about methods to invest with confidence even in precarious times such as these in TSP Investing Strategies: Building Wealth While Working for Uncle Sam “TSP Investing Strategies”), for both conservative buy-and-hold investors and for those looking to take on more risk.

Related topics: long-term-investing debt