As Debt Ceiling Fear Looms Here’s What Investors Can Be Doing To Protect Their Portfolios

It’s a race against time. The United States is approaching a 2011-style debt ceiling market meltdown, leaving investors and traders worried, with many looking to jump ship and park their cash elsewhere amid the ongoing tumultuous market conditions. 

Hearing that one of the world’s leading economies could soon be running out of cash and default on its debt is a sight of terror for even the most novice of investors. 

With the U.S. hitting its $31.4 trillion legal debt limit, the Treasury and bipartisan leaders are taking measures to cut back spending just so to keep the bills paid and the lights on. 

Yet, this isn’t a recent occurrence, with economists, seasoned investors, bankers, and Wall Street analysts following the developments of the story since as early as January this year. 

Back then, Treasury Secretary Janet Yellen warned that if the U.S. government can’t reach an agreement on raising the federal debt limit, the aftermath could send shockwaves across the world, leading to a greater global financial crisis. 

The simple and complex solution 

The solution is simply to raise the debt ceiling. Unfortunately, the political clout surrounding this solution has both Democrats and Republicans divided among themselves. 

While the Biden Administration and The White House are open to raising the U.S. debt limit, a wing of the Republican Party isn’t directly opposing this solution, but not without making extraordinary financial cutbacks on social welfare and Medicare programs. 

The scenario seems all too familiar, however. Back in 1995, when Newt Gingrich was speaker of the House of Representatives, Gingrich threatened to plunge the U.S. economy into default, unless the then Clinton Administration made spending cutbacks. 

Then there was a similar instance in 2011, with Speaker John A. Boehner and House Republicans demanding the Obama administration to slash its expenses for its support to raise the debt limit. 

Despite the political back-and-forth, the debt ceiling crisis of 2011, left markets crashing down and prompted the U.S. to lose its once-perfect AAA credit rating from the S&P. What followed after the downgrade was a 15% decline in the S&P 500, and those sectors with close funding tied to the U.S. government, such as health care and defense, among others, fell by 25%. 

Now, history is once again repeating itself, with lawmakers in a deadlock over whether to loft the debt ceiling. If a deal could be struck in time - before June 1, 2023 - the increase will be accompanied by spending cuts across government branches. 

Unable to reach an agreement in time could send further economic and financial turmoil across the global economy. Here in America, conditions could only further deteriorate, throwing out all hope for a possible soft landing, and the impending possibility of a hard recession up ahead. 

Navigating tumultuous conditions 

The last several years on the stock market have been anything but ordinary, with investors and traders finding it harder than ever to remain buoyant amid volatile conditions. 

From the outside perspective, this scenario doesn’t look too severe, but once you start widening your peripheral vision, you start to understand the severity of the situation and how it could ripple through the global economy. 

Ravaged by years-long high inflation and aggressive monetary tightening, geopolitical tension, and the potential of a widespread recession - many investors are left feeling defeated, with not enough arsenal remaining to fight off yet another crisis. 

Leaving conditions to unravel further would pose a huge risk to the American economy that would later play out on the global stage the International Monetary Fund warned earlier in April 2023. 

There’s perhaps already enough uncertainty hovering over the U.S. economy and money markets, and exposing it to these additional risks could leave American economists and investors to deal with the repercussions. 

If the U.S. is to default on its debt, the negative impact could spread to a wide range of financial assets including U.S. bonds, equities, and the dollar. This poses a broad range of new risks to investors that already have a hard time trying to navigate conditions as is. 

What investors should start considering 

Looking to park their cash in saver, less volatile assets has been hard to manage, considering the wider long-term effects of broader market declines against the backdrop of the debt ceiling crisis. 

The outcome of not taking action sooner can have detrimental effects on economic activity and portfolio performance in the near term. 

Here’s what investors need to consider in the coming months. 

Minimize exposure to government-backed companies

One of the first things investors and traders need to start looking at is their risk appetite, and how much of their portfolio is currently dedicated to companies with a higher revenue exposure to the U.S. government. 

Often publicly traded companies that are related to the U.S. government, such as healthcare, defense, and infrastructure run the biggest risk if the debt limit is not raised. 

Without sufficient cash flow to pay contractors or initiate new programs, these companies typically run the biggest risk of making further financial cutbacks until conditions start to improve again. 

A number of companies to minimize portfolio exposure include Huntington Ingalls Industries (NYSE: HII) and Lockheed Martin (NYSE: LMT), both companies operating in the defense and technology sector. 

Further down the list are names such as Mercury Systems (NASDAQ: MRCY), an aerospace and defense company, that was selected to develop and provide secure packaging solutions for the Department of Defense State-of-the-Art Heterogeneous Integrated Packaging (SHIP) program.

CVS Health (NYSE: CVS) is also another company that has direct ties with the U.S. government, as the company serves a long-standing agreement to serve the Government-wide Service Benefit Plan. Under this plan, federal employees, retirees, and families can have improved access to prescription drug medication savings. 

During times of high volatility, capital markets tend to be more exposed to wider macroeconomic challenges, which in return can lead to greater losses on the investor front. 

Although it is worth saying that lowering stakes in these companies come with a near-term strategy, investors will need to consider the position these investment sectors take up in their portfolios.

Invest in high-quality international stocks

Instead of investors keeping a large portion of their portfolios positioned on domestic stock picks, another option would be to park their cash in high-quality international companies that have a track record of riding out difficult economic conditions. 

In a survey of more than 150 analysts, fund managers, and strategists covering 17 different global stock indices, more than half of them - 56% - expect a downturn in their local marketing within the next two to three months. 

Despite this negative outlook, the majority of those surveyed suggest that investors should continue keeping their finger on the pulse, especially those that prefer international stocks for a more balanced and diversified portfolio. 

Another place to look is emerging market equities that have been widely popular among Wall Street money managers in recent months following the further slowdown of the U.S. economy on the back of tighter lending and stubbornly high inflation data.

Looking at Sigma Lithium (NASDAQ: SMGL), a Vancouver, Canada-based lithium exploration and mineral extraction company has been gaining momentum on the back of rising electric car (EV) demand, and increasing sales for long lasting electric car batteries. The company has invested heavily in developing their Green Tech Lithium Plant, which runs on 100% renewable energy and 100% recycled water, further increasing investors interest in EV stock picks. 

A good choice for international stock picks includes HSBC Holdings (NYSE: HSBC), which reported a 38% quarterly revenue growth year-over-year in December last year. 

The Latin American eCommerce giant, MercadoLibre (NASDAQ: MELI), reported a 40.8% year-over-year revenue increase of $3 billion in its Q4 earnings call in February 2023. Furthermore, the company beat analysts' estimates by $0.93, after reporting GAAP earnings per share of $3.25. 

Ryanair Holdings (NASDAQ: RYAAY) could see a major upside in the coming months, as travel and tourism are set to make a strong rebound this year, following several months of pandemic-related border closures.

Last year the travel and leisure industry was exceedingly overwhelmed, as consumers took the skies in droves due to pent-up demand. Despite having to deal with higher operational costs and higher fuel prices, Ryanair flew more than 16 million passengers in April 2023, up from the reported 14.2 million passengers in April 2022. 

In January this year, the company reported revenue of €2.31 billion, up 57.1% year-over-year, and Q3 GAAP earnings per share of €0.18.

Keeping an eye on international stock options could provide investors with a suitable near-term solution, but can also help increase their overall portfolio diversification efforts in the long run. 

Consider government bonds 

Paradoxically, the root of the problem may often be the safer option for investors that are not too eager to expose their portfolios and wealth to international stock options, and other high-risk investment vehicles. 

While there is the risk that the government may default on its loans, buying bonds often tends to be on the lower risk side of the scale for investors. 

For those investors that are interested in government bonds, it’s best to consider how conditions will play out in the coming months, but also take into mind how the credit rating of the U.S. could potentially be affected in case the debt limit is not lifted. 

On the upside, however, it could be a good option, seeing that many economists and strategists are hopeful that the Federal Reserve has now finally concluded its tightening cycle after raising interest rates by 25 basis points on May 3, 2023. This marked the tenth consecutive hike in the last 14 months since the central bank started lifting interest rates back in 2022. 

There’s also the hope that inflation figures have started retracing, as aggressive interest rate hikes have slowed the economy and cooled borrowing. This could add to the upside of those investors taking up a position to buy government bonds, yet there is still the imminent risk that the government could default on its debt in the coming weeks.

It’s a hard call to make, and considering the negative impact it can have on the broader market and global financial ecosystem, investors should tread lightly until they’re certain of their choices. 

The takeaway 

This is not a new scenario, and there’s a high possibility that the government could lift the debt ceiling in the coming weeks, in fact, they only have until the start of June 1 to come to a final verdict. 

While it’s largely a political matter that could ultimately impact the wider economic cycle and market condition, investors should remain versatile during these times, and seek out investment vehicles that provide offshore growth opportunities. 

At best it’s possible to create a diversified pick of investments that can help investors ride out the economic downturn, yet, keep in mind that long-term growth is a crucial element that needs careful consideration regardless of what the outcomes may be.