Game Theory Offers Clue to Market Calm Amid Debt Impasse

The U.S. is hurtling toward a credit default that pundits universally agree would be catastrophic for the economy and financial markets. So why is the S&P 500 treading water near a nine-month high?

Game theory offers some insight, according to analysts at Citigroup. Simply put, investors could unload risk assets now and force negotiators into a deal — and then immediately regret that they sold. Holding tight, though, could lead to an impasse that eventually craters the economy and markets.

“Investors shouldn’t be seeking to game the politicians into a solution — that is a risky and uncertain proposition at best,” wrote analysts led by Nathan Sheets. “Rather, with or without an immediate market response, the debt ceiling brings heightened economic and financial uncertainty and other pressures. And investors are well-advised to respond to that reality, as dictated by their investment horizons and appetite for risk.”

The S&P 500, currently hovering just above 4,200, is around its highest level in nine months, propelled, in part, by news that lawmakers were making some progress on debt-ceiling talks in recent days. President Joe Biden will again meet with House Speaker Kevin McCarthy on Monday. Meanwhile, Treasury Secretary Janet Yellen said the U.S. is unlikely to reach mid-June and still be able to pay its bills, underscoring the urgency of reaching a deal.

“The reason that the market has held up is because most people on Wall Street don’t believe Congress is that stupid, and that simply this is another example of Congress teaching Hollywood a thing or two about drama,” said Sam Stovall, chief investment strategist at CFRA. “In the end, they will come to an agreement and I believe that is why the market is remaining fairly resilient — only the most bearish of bears, the most cynical of cynics believe that the extremists in DC want us to go into default.”

Stocks could rally after a resolution has been reached, he added.