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Does the US reaching its debt ceiling impact stock markets? Thumbnail

Does the US reaching its debt ceiling impact stock markets?

Markets & Economy

President Biden’s State of the Union address on February 7th highlighted some of the most consequential topics for the United States at the beginning of 2023. One of the more divisive issues is that of the US national debt which sits at a historic high of $31.4 trillion dollars1. Some investors are wondering what this news means for the stock market at large. 

It’s helpful to take a step back and look at a historical perspective. In its 245-year history, there are only two years that the US has not been in debt2. What makes the $31.4 trillion number significant is the fact that it represents the debt limit or debt ceiling – the amount of money the US government is authorized to borrow to meet its obligation (social security, medicare benefits, military salaries, interest on national debt, tax refunds, etc.). 

Rising national debt might be worrisome for some investors expecting an adverse impact on stock returns once the bill for all this spending comes due. However, the relation between country debt and stock markets is complex, in part because sovereign solvency is dependent upon many factors other than just debt level. 

Debt is also generally a slow-moving variable whose expected value should be incorporated in market prices. Consistent with this belief, the evidence suggests there has not been a strong relation between country debt and equity market returns. Research by Dimensional compared average returns of countries sorted into high- and low-debt groups and discovered that there is little evidence that debt levels are useful in predicting equity premiums. Therefore, a relatively high debt/GDP ratio should not alone deter investors from holding that country’s equities. On average, our research showed that even large increases in debt/GDP have not impaired equity markets. 

Additionally, the US is not alone in having a high debt level. Exhibit 1 shows that most of the Organization of Economic Co-operation and Development (OECD) member countries have general government debt/GDP ratios above 50%, with 13 countries—including the US, Japan, France, and United Kingdom (UK)—exceeding 100%. 

Exhibit 1: General government debt as a percent of GDP in OECD (2021 or latest available)3
Source: Debt/GDP data from OECD (2023). General government debt as a percent of GDP, 2021 or latest available. General government includes central, state, and local governments and the social security funds they control. Debt is the sum of currency and deposits; debt securities; loans; insurance, pensions, and standardized guarantee schemes; and other accounts payable.

While news articles about the US debt ceiling and “impending debt crisis” can be alarming for investors to read about, it is important to consider the evidence which shows a lack of relation between a country’s debt and stock market returns. 

Whether it be debt, economic growth, inflation, or interest rates, we believe market prices quickly incorporate information and expectations. Regardless of the economic environment, the range of outcomes for the premiums—equity, size, value, and profitability—can be large. The challenge of trying to outguess the markets based on macroeconomic indicators, like national debt, can come at the substantial opportunity cost of missing out on the premiums when they arise. 

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Dimensional funds are distributed by DFA Securities LLC.
1. https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/
2. https://www.cnn.com/2023/01/18/politics/us-debt-ceiling-what-matters/index.html 
3. https://data.oecd.org/gga/general-government-debt.htm