Will Congress Crash the Market in 2014?

Source: The Associated Press.

At times it has seemed as though Congress has been deliberately trying to sabotage our economy over the past two years. First, there was the debt-ceiling debacle of 2011, which resulted in a downgrade of the U.S. credit rating by S&P for the first time in our history. Then there was the fiscal cliff and sequestration shenanigans at the end of 2012 and beginning of 2013. More recently, we experienced the government shutdown, and yet another debt-ceiling crisis last month.

These periodic attempts at political seppuku, alas, are not without costs to our economy and markets. In 2011, the Dow Jones Industrial Average (^DJI 0.03%) plummeted by 634 points on the first day of trading after the downgrade, and the index lost 400 points in the midst of the fiscal cliff crisis in December 2012. In addition, the recent government shutdown may have cost taxpayers as much as $2 billion in lost productivity, according to the White House budget office. We may have even been minutes away from another downgrade by S&P, according to a report by Newsweek.

What'll they do for an encore?
Perhaps unsurprisingly, legislative dysfunction has caused Congress' approval rating to hit an all-time low of just 9%, according to a recent Gallup poll. Even hipsters, of all things, are more popular than Congress right now.

One would think that Congress might be sufficiently chastened, at this point, by the widespread criticism of their recurring brinkmanship on crucial issues facing our economy. Should we hope for a change of tack by Congress in 2014, or will it be more of the same? And what will all of this mean for markets and investors?

Let's first consider where things stand right now, in November 2013. The recent deal approved by both the Senate and the House of Representatives funds the government through mid-January and suspends the debt ceiling until Feb. 7. Meanwhile, a bipartisan committee from both chambers has already begun negotiations with the hopes of avoiding another crisis.

There's one additional detail that investors should be aware of as we approach the reinstatement of the debt ceiling on Feb. 7. According to Bloomberg, the Treasury Department should be able to stay under the ceiling for about a month or so after the deadline. This could possibly push the debate over the debt ceiling closer to congressional midterm elections. Now, we're not political scientists, but we can imagine that impending elections might make politicians even less likely than usual to compromise on issues like spending and taxes.

What does it all mean for the market?
The key for investors is to look at incentives for House Republicans. It's possible the party will decide it's not in their best interest to prompt another fight over the debt ceiling in 2014. The Republican Party's approval rating sank to the lowest recorded level of any party in the United States during the 2013 government shutdown and debt-ceiling crisis. In polling, roughly three-quarters of the public disapproved of their position to shut down the government over Obamacare. Perhaps, one might think, with midterm elections coming up, they'll be more risk-averse.

But that way of looking at the question would have predicted things wouldn't have gotten as far out of hand last year, too. Although the crisis may have been bad for the party as a whole, many House Republicans felt more pressure to fight to shut down the government and risk a debt-ceiling breach than to fight to end the standoff, since they represent very conservative districts and fear Tea Party challengers more than they do Democratic candidates. Unless business groups are able to credibly threaten those incumbent Republicans whose position on the debt ceiling risks the U.S. Treasury's full faith and credit, the approaching midterms don't change their incentives -- they might actually exacerbate them.

What can we do?
If another fight over the debt ceiling heats up in 2014, traders will be parsing the every twist and turn of the negotiations to try to profit from market fluctuations.

But long-term investors shouldn't bother. In the unlikely event Congress doesn't raise the debt ceiling, causing the government to default on its bills and precipitating a financial crisis and massive recession, we'll have bigger things to worry about than the value of our stock portfolios. And if Congress does raise the debt ceiling, then any attempt to profit by betting on short-term market moves is just market timing.

For investors, analyzing what to invest in is almost always a better use of our time than trying to read the market tea leaves to figure out when to invest.