The Investment Scientist

Italian Debt Crisis + US Debt Ceiling: Now What for Stocks?

Posted on: July 14, 2011

If the recent headlines make you feel like the international financial order is heading toward a cliff, I would not blame you. Apparently, the Europeans have managed to spread their sovereign debt crisis from Greece to Italy, a far more significant country for the world economy. Here in the US, politicians are engaged in high-stakes political brinksmanship regarding raising the debt ceiling, without which the US will go into default for the first time in its history.

No wonder I am getting calls left and right asking whether we should pull out of stocks. Not so fast. Let’s examine what happened over the last year and maybe we can learn some lessons. Let’s look at the headlines about this time last year:

Europe Crisis Deepens as Chaos Grips Greece” – WSJ, May 6, 2010

Fearful Investors Are Pulling Out” –USA Today, May 20, 2010

Housing Prices Remain Weak” – WSJ, May 26, 2010

Fear Returns – How to Avoid a Double-Dip Recession” – Economist, May 29, 2010

Spill Tops Valdez Disaster – Deep Trouble” – WSJ, May 28, 2010

Discouraging Job Growth Batters Stocks” – Los Angles Times, June 5, 2010

Economic Outlook Darkens” – WSJ, June 2, 2010

Bond Fund Managers See Signs of a Bubble” – WSJ, June 8, 2010

Since then, the market has rallied. The one-year returns of various indexes and funds are listed below:

Index or Fund One-Year Return
Dow Jones 20.53%
S&P 500 20.3%
Nasdaq 24.75%
DFFVX (DFA Target Value Fund) 27.75%
DFSVX (DFA Small Cap Value Fund) 31.37%

With all that bad news hitting you like a brick smacking at your face, could you have imagined the market would rally this much?

The lesson: There is no shortage of bad news, but there is little correlation between bad news and bad returns.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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