It’s happening again…
Fears over a U.S. debt default are fueling a market drop. That’s because the federal government expects to hit its debt ceiling on June 1.
So we’re just a week away from the “drop dead” date.
The debt ceiling is the statutory limit on the amount of debt the U.S. Treasury can have outstanding to pay its current obligations.
Talks between House Republicans and the Biden administration to raise the debt ceiling have been ongoing and contentious. If they don’t come to an agreement by the June 1 deadline, there’s a chance the U.S. defaults on its debt for the first time in history.
That could cause severe damage to the U.S. economy, including a market crash and millions of job losses.
The market is starting to price in this possibility. Since hitting its 2023 high of 4,212 on May 19, we’ve seen the S&P 500 slide 1.6%.
The Council of Economic Advisors forecast a 45% drop from if no deal is reached by the June 1 deadline. That would take the S&P 500 back to 2,500 – a level last seen in March 2020 during the COVID crash.
The markets didn’t even drop 40% in March 2020 during the early days of the COVID-19 outbreak. Back then, many felt like the world as we knew it would come to an end.
Most likely, the White House and Congress come to a deal on the debt limit. After all, they’ve raised it 78 times since 1960. So I wouldn’t bet against a 79th time.
But there’s always a first time for everything. And this year could be the first that America actually defaults on its debts.
In Thursday’s Daily, I showed you two safe ways to profit from the debt ceiling crisis – plus one aggressive bonus play. You can check them out right here.
Today, I’ll share six steps to prepare your portfolio in case the debt limit talks break down, throwing the market into a tailspin.
Your Six-Step Debt Default Preparation Guide
At PBRG we recommend a diversified portfolio broadly broken down into three asset classes.
This diversification gives us plenty of upside opportunity. But it also provides us with downside protection from any single asset class.
(Our asset classes are equities, fixed income, and alternatives such as cryptocurrencies and collectibles.)
If you want to make sure your portfolio survives market volatility, run it through the six-step checklist below. That way you’ll be ready for anything the market throws at you, including a U.S. debt default.
Is your portfolio diversified? Numerous studies show that asset allocation accounts for more than 90% of your investment returns. Greater diversification also results in lower risk. So a good start is owning a mix of domestic and foreign stocks, bitcoin, real estate, gold, and even bonds, especially now that interest rates are the highest in 15 years.
Do you own true alternatives? Be comfortable with being uncomfortable. In other words, think outside the box. Get some exposure to alternatives like collectibles and cryptocurrencies. While volatile on a daily basis, they’ll generate long-term outperformance. Plus, if you sell half your position once it’s doubled, you can play this volatile asset mix with the “house’s money.”
Do you have a rainy-day fund? Cash gives you options. You never know what opportunities life might throw at you. Whatever they are, cash typically meets the need better than anything else. So it’s crucial to hold some and to own assets like dividend stocks and bonds that throw off more cash on a regular basis.
What are your position sizes? Position sizing refers to the percentage or dollar amount of the investments in your portfolio. Our simple rule of thumb is this: A position should be no more than 2.5–5% of your portfolio’s value. And smaller plays like cryptocurrencies might even just be a 2.5–5% stake within your total crypto holdings.
Do you use stop losses? Stop losses let you control how much you’re willing to lose. They eliminate emotion (an investor’s greatest enemy) from sell decisions. And they protect your investments from devastating losses. We suggest a trailing stop loss, so that as a position moves higher, you can still make a profit when the trailing stop is hit.
Do you have an allocation to safer stocks? Invest in companies with quality balance sheets, attractive valuations, solid earnings, and strong growth prospects. Companies with these qualities tend to pay a growing dividend payout each year, which is why we’ve been adding in some of those names for our subscribers.
We use this same stress test in our flagship advisory, The Palm Beach Letter.
Since Daily editor Teeka Tiwari took over in 2016, the recommendations in our portfolio, both open and closed, have achieved average returns of 285%. And we’ve had an annualized return of 130.4%.
During that period, we saw several crashes, including:
2018 Crypto Winter, when bitcoin and Ethereum dropped as much as 83% and 94%, respectively…
The December 2018 Fed Scare when the market plunged 20.2%…
The pandemic-related crash of March 2020 that saw the S&P 500 drop as much as 35.5%…
And 2022’s bear market, with the S&P down about 25% from its peak.
In comparison, the S&P 500 has grown 97.8% over that same period. That’s an average annual return of 12.2%.
So our Palm Beach Letter portfolio has done 10.7x better than the S&P 500. And with about 20% less volatility.
This checklist has served us well in the past. And it’ll continue to do so going forward.
We suggest you print it out and keep a copy handy.
After you do that, it’s time to “gut check” your potential losses in the event of a U.S. debt default, which could send us into a bear market.
Can You Sleep Well at Night if the U.S. Defaults?
Since the end of World War II, the S&P 500 has experienced 11 bear markets (declines of at least 20%). The average loss has been about 34%.
So to stress-test your portfolio, apply a 34% loss to your equity portion.
For example, say you have $100,000 of assets… and you allocate 50% to bonds and 50% to stocks. A 30% tumble in stocks means you’d lose $15,000 of your nest egg.
Or if that’s too hard to imagine, think back to how you fared in February–March of 2020 during the outbreak of the coronavirus. U.S. stock markets dropped 30–35% then, well into bear market territory.
Now, it’s gut-check time.
Can you withstand a loss like that?
Will you be able to sleep well at night?
Do you have time to recoup those losses?
If any of the answers are “no,” you should revisit your asset allocation… and consider trimming some of your more volatile positions.
So if worries about a U.S. debt default keeps you up at night, stress-test your portfolio now. This way, you won’t panic if things get worse.
Instead, you’ll be well prepared even if Congress and the White House can’t get their act together and reach a debt limit deal by the June 1 deadline.
And you’ll be positioned to buy into stronger investment ideas when the market recovers.
Analyst, Palm Beach Daily