Default will be avoided, at least for a few months. Policymakers in Washington agreed to a last-minute debt ceiling deal Wednesday night to end the 16-day government shutdown and raise the U.S. debt limit. As the unsettling practice of governing by crisis becomes all too common in Washington, you can’t blame the analysts at Fitch Ratings for giving the U.S. government’s AAA-rating a negative outlook — it’s literally the least they could do. Remember, it was in the aftermath of the debt ceiling debate in 2011 when S&P downgraded U.S. debt from AAA to AA+.
For all the headlines and partisan politics, the markets actually took the government shutdown and looming debt ceiling in stride. From the beginning of the government shutdown on October 1 through Tuesday night, when a solution was far from certain, the S&P index was up 0.2%, and has since rallied 2% or so. And while most investors and finance publications focus on the Dow Industrials and the S&P 500, several small-cap and mid-cap indexes hit brand-spanking-new all-time highs on Wednesday. As for bonds, the 10-Year Treasury yielded 2.66% on October 1. Today it yields 2.61%.
While I am glad to see that Congress was able to come to an agreement, as you’ve likely heard, it’s only a temporary solution. At this time, the deal is projected to fund the government through the middle of January of next year, and we’d hit the debt ceiling in early February. As 162 congressional representatives voted against reopening the government last night, we unfortunately may have to go through this whole song and dance again. I suspect that long-term investors who tune out the noise from Washington, or as much noise as they can, will continue to be rewarded.
We’re halfway through October and it’s a perfect time to think back five years to October 2008. Why? Because October 2008 was the single worst month of the entire financial crisis, with Vanguard 500 Index Fund (VFINX) dropping almost 17% in the month alone. The reason for reflection is that when October 2013 ends, the five-year returns for all of Vanguard’s funds (and any others you may own or be looking at) will be calculated without that fear-inducing month in them. Dan Wiener and I expect five-year returns to skyrocket, as they have been doing for the past year already. Consider that one year ago 500 Index’s five-year return clocked in at just 0.3% annualized. Last month that number was 9.9%. Assuming the month ends about where it is today, 500 Index’s five-year annualized performance should jump to somewhere around 15%.
Why mention this? Expectations. Many investors make the mistake of simply taking past returns and projecting them forward in a straight line. And while it would be nice, returns of 15% a year are not sustainable forever. The past four years—nearly five years now—have seen stocks deliver some strong returns. This doesn’t mean we can’t still make money from here, but I wouldn’t expect to see the same level of returns from stocks over the next few years. Keeping our expectations in check will make it easier to stick with our long-term investing plan.
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.