Macro Wrap – What Really Caused the Selloff in August 2011? Not What You Think

by Enis September 26, 2013 8:15 am • Commentary

Market consensus seems to have crystallized around the fact that Debt Ceiling Debate 2013 has much less potential to harm markets compared to its 2012 or 2011 versions.  Cardiff Garcia at FT Alphaville summarized well that standard view:

To the seasoned finance blogger, US Congressional asshattery lacks the terrifying intrigue it had in 2011.

The world was in worse shape back then. It was pre-LTROs in Europe and high season for Eur-exit speculation, while in the US we were confronting another dispiriting summer slowdown and the legitimate possibility of a double-dip recession. As the possibility that the debt ceiling wouldn’t be lifted in time became frighteningly real, financial markets started flashing signs of acute distress, and consumer confidence cratered.

We got through it. The debt ceiling was raised enough to avoid approaching it again until after the end of the 2012 election.

And it’s also been easy to think that once again Congress will come to its senses at the last minute and, at the very least, avoid catastrophe.

Cardiff Garcia, by citing Ezra Klein, actually goes on to lay out why this year’s situation could be more dangerous than currently assumed.  But let’s put the politics aside, since that’s not my area of expertise.  What about the market comparison between 2011 and 2013?

Rather than talk in broad sweeping generalizations, here are the facts:

   Jul-11   Sep-13
     Level of SPX Index    1350   1700
     SPX Trailing 12 Month EPS    90   104
     Trailing 12 Month P/E    15   16.35
     Prior 4 Qtr Avg. GDP    1.875%   1.625%
     Prior 6 Month Avg. ISM Manu    57.2   52.2
     Prior 6 month Avg. ISM Non-Manu    55.7   54.8
     Prior 6 Month Avg. Payrolls    183   160
     10 Year Treasury Yield    3.00%   2.65%


So was the world in “worse shape” back then?  Were we confronting a possible double dip recession in the U.S.?  No.  The trailing U.S. data was actually better in July 2011 than in Sept 2013.  Across the board better.  You could argue that the forward-looking forecast was not as optimistic, but that’s not hard data, simply a guess.  The hard data was better in July 2011 than it is today.

Moreover, the SPX index, valued on trailing 12 month earnings, was actually cheaper.  We were only 2 years into an economic recovery, not 4 years (for you business cycle followers).  In short, stocks were priced more cheaply, and at an earlier part of the cycle.

How about the resolution of the debt ceiling?  What actually happened in the summer of 2011?  Here’s the ABC News excerpt from July 31, 2011, when Obama and Boehner came to a last-second agreement (as is expected to happen this time around):

ABC News’ Z. Byron Wolf (@zbyronwolf) reports:

It took the threat of economic collapse and a long, contentious negotiation — and there will still be votes in Congress before it’s truly done — but lawmakers from both parties and the White House have reached a deal to raise the nation’s credit limit — the $14.3 trillion debt ceiling — by $2.4 trillion, likely through 2012.

This all happened over the weekend, with the announcement on Sunday, July 31st.  SPX Futures shot up 1% on Sunday evening on the news.  Prior to the announcement, the SPX index had been selling off, but had held its 200 day moving average on Friday, July 29th.  I’ve circled in red the first day of trading in the index following the debt ceiling agreement:


SPX Daily in 2011, red circle is debt ceiling deal, green circle is S&P downgrade, Courtesy of Bloomberg
SPX Daily in 2011, red circle is debt ceiling deal, green circle is S&P downgrade, Courtesy of Bloomberg

Most traders still refer to the August 2011 swoon as due to the Standard and Poors downgrade of the U.S. debt rating.  But that didn’t happen until after the close on August 5th, which I’ve circled in green.

I point all this out because between the debt ceiling extension on July 31st and the S&P downgrade on August 5th, the SPX index declined more than 100 points from high to low.  That was AFTER a deal was announced to break the impasse, and BEFORE the downgrade. The meat of the selling in the summer of 2011 occurred AFTER the supposed tail risk of a U.S. default was already resolved, and before the bad news about the downgrade.

Meanwhile, U.S. data was actually pretty good.  The main (and crucial) difference between today and July/August 2011 is the lack of stress in Europe.  Back then, Italian and Spanish yields were shooting higher, and European banks were under serious strain.  Perhaps that was the bigger cause of that decline than anything related to U.S. politics.  Regardless, it’s not the black/white story that most seem to tell ex-post-facto.

I don’t know what’s going to happen this time around.  The market is a mysterious mistress.  But with everyone extrapolating from historical precedents, it’s worth checking the simple facts too.