All eyes have been glued to Washington lately, where our leaders are engaged in heated debate over how best to reach a compromise on raising the debt ceiling and cutting back on government expenditures. There's no shortage of analysis out there with respect to how a final deal might be cut or whether the U.S. will default on its debt obligations. But whether you consider yourself an optimist or a pessimist with respect to the whole situation, there are steps you can take now to position your portfolio either for economic Armageddon or for continued, if sluggish, growth depending on your outlook.
If you think default is likely...
If you want to plan for the worst, obviously your first step would be to short U.S. Treasury bonds. If the U.S. fails to meet its debt liabilities, interest rates would likely skyrocket as investors would suddenly demand much higher payments to buy risky U.S. debt. Treasuries would sink, dealing a harsh blow to investors across the globe. In such an event, a fund like ProShares Short 7-10 Year Treasury ETF (NYSE: TBX) or even the ProShares Ultra Short 20+ Year Treasury ETF (NYSE: TBT) would be a good bet to hedge against falling Treasury prices. (Perhaps not coincidentally, House Majority Leader Eric Cantor, R-Va., has a position in the latter fund!)
Likewise, a U.S. default would send the prices of certain commodities soaring, most notably gold. The good old inflation and economic turmoil hedge has already breached $1,600 an ounce in recent days. You can bet that gold will move a lot higher in the event of a U.S. default. To make a play on gold, a low-cost exchange-traded fund like iShares Gold Trust (NYSE: IAU) or SPDR Gold Shares (NYSE: GLD) would probably be a good choice in this scenario.
Another way to profit from a default is to invest in the currencies of other nations. A U.S. default would likely help fuel a collapse in the dollar. As a result, investors with exposure to foreign currencies would benefit. In the ETF market, you can get exposure to any number of nations' currencies you think will strengthen against the dollar or just bet on the downward path of the dollar itself via a fund like PowerShares DB U.S. Dollar Index Bearish ETF (NYSE: UDN).
If you think default won't happen...
If you see the glass as half full, you actually have fewer opportunities to make a big profit, but that's ultimately better for the economy in the long run than a default would be. If an agreement is made and the debt ceiling is raised, expect at least a short-term boost in the stock market. I don't know how big of a boost there will be and just how long-lived it will be, but the equity markets are likely to embrace news of a deal. That means domestic equity investors should make out well, at least in the short run. Here, broad market exposure through an inexpensive exchange-traded fund like Vanguard Total Stock Market (NYSE: VTI) or SPDR S&P 500 (NYSE: SPY) is a smart idea.
However, the fiscal problems facing the U.S. won't be going away anytime soon, even if the debt ceiling is raised. Flagging economic growth and a growing national debt will keep returns over the near and intermediate term in check. In a slow-growth economic environment, you'll probably want to boost the income-producing side of your portfolio. That means focusing on blue-chip dividend-producing names, like those found in low-cost ETFs such as Vanguard Dividend Appreciation ETF (NYSE: VIG) and SPDR S&P Dividend ETF (NYSE: SDY). You surely won't see the types of gains you would if you bet against the U.S. economy and a default materializes, but you should still be able to make reasonable gains over a longer time frame.
Playing the odds
Ultimately, I think the odds of the U.S. entering technical default are very slim. While negotiations will likely go right down to the wire so both parties can save face with their respective constituencies, neither side of the aisle wants to take responsibility for the serious economic fallout that would likely result from a true default. Given that Treasury bond yields have remained stable and even fallen slightly since that start of the year, the market has pretty much completely discounted the possibility of a default. I'm pretty confident that a deal of one sort or another will be reached and that the debt ceiling will be raised. While risk-seeking investors could stand to make a mint on a U.S. default on the very small, outside chance it does occur, the odds are not in their favor. So think long and hard before betting the farm against the U.S. economy right now.
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