Why Didn’t the Stock Market Go Up?

If investors were worried about government debt, the stock market should have gone up:

Why didn’t the stock market go up?, by Roger Myerson: You might have thought it obvious that the stock market would go down after S&P downgraded US government debt. Bad news about US debt makes investors worry, and worried investors are usually less enthusiastic about holding stocks.

But there is something wrong with this view. ... If serious investors were actually worried about the real value of US government liabilities then they should tend to move out of bond markets and into real investments like the stock market, which should drive stock prices up. Such a move would help get real investment started, which would help get people back to work; but that is not what we saw today...

So to explain the stock market decline, we have to look at the other side of the story, the very real possibility that a politically constrained US government might have to cut expenses for essential government services. Broad fears of a crippled US government that is unable to enforce laws or invest in infrastructure could do very serious damage to investment and economic growth in America. Indeed the possibility of such government paralysis could be far more economically damaging than any marginal increase in taxes.

Thus, there is every reason to believe that investors are reacting, not to fears of too much government debt, but to fears that the government might become unable to spend enough to do its part in maintaining the strength of this country. ...