The unthinkable has finally become a reality: The U.S.
government has shut down.
A legislative deadlock triggered by President Barack Obama's
Affordable Care Act (aka Obamacare) combined with fears of a U.S.
debt default has resulted in shivers of fears in the economy.
Talk of economic Armageddon, crashing markets and mayhem has
dominated the press over the past several weeks.
History makes it clear that the shutdown fears are unfounded.
There have been 17 government shutdowns since 1976 with 21 days
clocking in as the longest. The current shutdown makes
While shutdowns are relatively common, the real worry is the
pending U.S. sovereign debt default slated for Oct. 17. Although
the definition of default is debatable, it is generally taken to
mean that the United States can no longer pay all its bills.
As you can see, the U.S. has tremendous obligations. According
to the Bipartisan Policy Center, on Oct. 17, the U.S. will have
about 68% of the funds needed to pay its bills the following
Although this is a highly unusual situation for the United
States, it has come close to happening in the past. In fact, some
economists argue that the U.S. has defaulted on its obligations
several times. This is due to the inexact definition of
No one really knows for certain what a U.S. debt default would
do to the economy on a national or global scale. Guesses run the
gambit from a Greece-style economic disaster to very little
effect at all.
The good news is, all it takes is an agreement to increase the
debt ceiling to avoid the situation altogether.
While it remains highly unlikely that the government will let
a default occur, if it does, the value of U.S. bonds will likely
plunge. This is due to the fact that U.S. bonds would be believed
to more risky. The lower bond value would result in higher
yields, thus worldwide interest rates will increase.
It's important to note that even Treasury Secretary Jack Lew
has said he doesn't know what will happen should the default
occur. While I firmly think that the default scenario will be
averted, smart investors know ways to protect their capital
should the unthinkable occur.
Here are four things that may happen should the U.S. default,
and how you can profit.
|1. Plunging Stock Market
Nimble investors could make impressive profits by shorting
the stock market prior to the default. Inverse
exchange-traded funds (ETFs) such as
ProShares Short S&P 500 (
Direxion Small Cap Bear 3X Shares ETF (
make putting on a short-term short position an easy
proposition. The good news is that lower stock prices mean
higher dividend yields.
Income investors with capital to invest after a market
plunge could earn shockingly high yields due to the lower
stock price. In addition, a stock market plunge will
provide brave investors a powerful, perhaps
once-in-a-lifetime opportunity to purchase stocks at vastly
Finally, option contracts known as puts can be purchased to
protect your portfolio against a plunge. One put is
purchased per every 100 shares that you own in specific
companies; a hedge can also be built by purchasing puts on
SPDR S&P 500 ETF Trust (
. Puts will enable you to lock in some of your yearly gains
regardless of what happens in the stock market.
|2. Surging Gold Prices
Gold has long been thought of as a safe harbor against
economic turmoil. The price of the precious metal should
climb as hard-asset investors seek shelter from the pending
U.S. default. Stock investors can anticipate a spike in
gold's value by purchasing shares in the
SPDR Gold Trust (
|3. Spiking Interest Rates
Interest rates will likely spike should the U.S. default
become economic reality. Investors can take advantage of
this situation by shorting Treasurys. That's not as complex
as it sounds, thanks to the advent of inverse Treasury ETFs
such as the
ProShares Ultra Short 20+ Year Treasury ETF (
|4. Weak Dollar Benefiting
A U.S. debt default will vastly weaken the U.S. dollar,
which could produce favorable foreign exchange rates for
multi-national corporations such as
Danaher Corp. (DHR)
. This is important to keep in mind regardless of U.S.
default when choosing investments.
Risks to Consider:
It costs money to hedge your portfolio or prepare to profit
should a U.S. default actually occur. In other words, protecting
your portfolio isn't free. Therefore, investors need to weigh the
odds of a U.S. default before making any changes.
Action to Take -->
As with all investing, maintaining a diversified portfolio and
having any excess capital ready to deploy into opportunities is
the best way to approach the unlikely default. If it occurs,
investors with capital will likely have an opportunity to
purchase stocks at very depressed prices. However, if you are
strongly convinced the default will occur, prudent and
well-balanced hedging through put options and the options listed
above makes good sense.
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