Lately, I have been getting many questions about what is going to happen if:
#1 the U.S. loses its AAA credit rating?
#2 the debt ceiling isn't raised by August 2nd?
#3 law makers can't agree to a budget?
I tell them it is best to be cautious at this moment because we have never had to deal with this issue and there are a lot of bad ideas being floated around.
In most instances, stocks go up when treasury bonds go down and vice a versa. This provides diversification to your investments and can help avoid wild swings in your account balances from month to month.
So far, the bond market doesn't seem to be worried as interest rates on the 10 year Treasury Note have been moving down over the past 4-months (when rates go down, prices go up). Bond prices are moving higher by European problems and the belief that an agreement will occur over the debt ceiling/budget.
Meanwhile, stocks have been about even with swings up if investors hear news that a deal is imminent and go down if the two sides stop talks. Earnings by corporations have been uneven for the 2nd quarter adding to the gyrations in the market.
What happen's if we go past the arbitrary August 2nd deadline and there is no solution? First, there is no consensus among economists, politicians, or financial analysts as to what will happen to stock and bond prices because we have never had this scenario of not increasing the debt ceiling. There is a lot of scare tactics going on right now to try to push one side to an agreement.
That being said, my biggest fear is that stocks and bonds will go down in tandem and stir up panic across the world. One would be wise to approach these events by being cautious, cutting back on the amount of stock investments, having short-term bonds and keeping some extra cash. Gold is a good hedge against this uncertainty. If a big sell-off happens one will have money to buy at temporarily lower prices. I say temporary because a deal will certainly be reached by Congress and the President in short order pushing prices on investments back up.
Long-term, the AAA rating will remain an issue because unfunded entitlement programs are enormous and will put future financial strain on our economy. Slow economic growth is not raising the necessary tax revenue to pay for current government spending. The idea of raising tax rates is akin to what politicians did in the mid-1930's helping to prolong the Great Depression. How our current budget problem is solved and over how many years will determine if we keep the AAA rating.
No one knows exactly what will happen so it is prudent to remain cautious during these one of a kind economic events.