The current debt ceiling talks remind me a lot of Kabuki theater…
The ancient Japanese art is known for its formal costumes and heavily stylized and dramatic performances.
The political theater we’re seeing from House Republicans and the White House is no different. In fact, we already know how this story ends.
Since 1960, the U.S. has hit its debt ceiling 78 times. That’s more than once per year. Each and every time, the debt limit has been raised.
As for the current iteration of The Debt Ceiling Comes to Capitol Hill, it’s not too much different from the version we saw in 2011.
Back then we had a similar cast: a Democratic administration featuring then-Vice President and now President Joe Biden against a GOP-controlled House.
The plot was nearly identical, too…
Like today, future spending and tax cuts were on the negotiating table in 2011 with a fast-approaching default deadline winding down like a ticking time bomb.
We came so close to the wire that Standard & Poor’s downgraded America’s pristine, AAA credit rating. It was the first credit downgrade in U.S. history.
As default approached, the stock market trended lower. From July to August, the S&P 500 fell by 16% peak-to-trough.
With everything on the line – and just two days before the Treasury expected to run out of money – the Obama administration and Congress finally reached a deal.
So as we approach the June 1 default deadline, you shouldn’t be too concerned about the United States welching on its debts.
In the end, the most likely outcome is a deal right before the timer hits zero – just like we saw in 2011.
So why is this bit of theater so important to you?
There’s a chance history doesn’t repeat itself, and the president and Congress miss the June 1 default deadline. In that case, you’ll want to protect yourself from the fallout.
The good news? I’ll show you two conservative ways to protect your portfolio.
The better news? I’ll show you how you can come out of this latest debt limit crisis ahead of the crowd.
Two Conservative Ways to Protect Your Portfolio
Ironically, a sound bet in the case of a debt default would be long-term U.S. Treasuries. By long-term, I mean Treasury notes or bonds with a duration of at least one year.
You may be asking, “Well, if the government defaults, how can it possibly pay people who hold Treasuries?”
That’s because any default will likely delay payments owed in short-term government debt. Longer-dated securities will pay out
We saw this back in 2011.
Despite downgrade warnings from the ratings agencies and a correction in the S&P 500… long-dated Treasury bonds rallied, with yields dropping from 2.5% in the summer to 2% in October.
(Bond prices have an inverse correlation to interest rates. So when interest rates drop, bond prices rise.)
Meanwhile, yields on short-term bonds have crept even higher in recent weeks. That reflects concern over whether they’ll get paid when due.
While short-term Treasuries are attractive right now for their highest yields in 15 years… those looking to hedge against a debt ceiling default may want to look out 1-2 years instead.
That’s because any default would be short-term in nature – likely only lasting a few days, or perhaps a week or two at most.
And bonds maturing during a debt default doesn’t mean a total loss for investors. The payout will simply be delayed until the debt ceiling is raised.
Those holding longer-dated Treasuries beyond a few weeks will likely see a decline in rates as the debt ceiling is resolved. As bonds move opposite yields, declining rates translate to rising prices.
The second asset that can protect your portfolio against a debt default is gold.
The yellow metal was the winner during the 2011 debt ceiling drama. Prices peaked in September over $1,900 per ounce – up 35% from the start of the year.
Today, gold is trading at $1,960, which is near its all-time highs set during the summer of 2020. And it’s often shown strength as a hedge against government uncertainty.
That’s why a small allocation to the metal is ideal most of the time.
It’s best to have some physical metal you can store safely somewhere – not a bank deposit box. That gives you some wealth that’s outside the traditional financial system.
If you prefer to buy gold through your brokerage account, consider the Sprott Physical Gold Trust (PHYS). It backs up each share with physical gold.
Just bear in mind: You can expect a gold sell-off as the debt ceiling Kabuki theater drops the curtain on its 79th performance. So this is more of a short-term hedge.
A Bonus Way to Play the Debt Ceiling Crisis
If you want to add a more aggressive hedge against a debt ceiling default to your portfolio, you can consider selling put options.
Put options allow you to generate hundreds or even thousands of dollars quickly without buying a single stock.
As I’ve detailed above, the chances of the federal government defaulting on its debts are low. The last 78 times it was in this situation, it simply raised the amount it could borrow.
That doesn’t mean we won’t see fear in the marketplace as these talks drag on, though. And more fear means more volatility.
That’s great for options traders because higher volatility means higher option premiums.
Two companies we’re following closely in the Daily are Keurig Dr Pepper (KDP) and CVS Health (CVS). They’re great candidates to sell put options against.
These are two defensive stocks that will continue to see consumer demand even during a debt default. Plus, they’re both trading at relatively attractive valuations.
If you consider selling put options, make sure to set aside enough cash in your account in the event you’ll have to purchase shares.
This will occur if the stocks are trading below the strike price on the day the options expire.
Selling options after they’ve had a big pop higher is another way to put some extra money in your pocket while traders are still fearful about the debt ceiling.
That’s how you come out ahead when you know how the show ends.
Analyst, Palm Beach Daily
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