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Featuring:Kenneth South
Founder & CEO / Tower 68 Financial Advisors


Worried About the Debt Ceiling? Three Ways to Protect Your Portfolio

By Lauren Foster

***Originally published in Barron's. A portion of this article has been omitted, due to the discussion of specific product performance.***

The debt ceiling standoff between House Republicans and the Biden Administration is likely to cast a long shadow over markets. President Joe Biden met with House Speaker Kevin McCarthy and other Congressional leaders on Tuesday but talks ended without a breakthrough.

“I didn’t see any new movement,” McCarthy said afterward.

If you’re a long-term investor, there’s a strong case to do nothing. If history is any guide, President Biden and House Republicans will strike a deal and avoid a default. We could see some sharp drops in stocks and bonds, followed by a relief rally. The market may then get back to its old worries over inflation, interest rates, and corporate profits.

“It seems a bit like Groundhog Day in that it seems we end up having this conversation every few years,” says Phil Huber, chief investment officer at Savant Wealth Management, with $19.5 billion in assets. “There’ll be some sort of 11th hour agreement.”

Still, volatility does offer trading opportunities and there are ways to fortify your portfolio.

Keep a defensive tilt in stocks.

The S&P 500 has shrugged at the debt fight, trading in a narrow range for weeks. The market appears to view it as a political impasse that will be resolved.

Adam Turnquist, chief technical strategist for LPL Financial, the nation’s largest independent broker-dealer, looks at the standoff through the lens of the 2011 fight. That year, the S&P 500 fell 19.4% from its April high to its October low. Large-cap stocks fared slightly better, down 18.3%, while value fared worse, down 22.3%. Small-caps were the weakest major category, down 29.6%.

If there’s a message in the data it’s that defensive sectors should outperform in a selloff triggered by U.S. debt worries. Utilities slipped just 0.8% from April to October 2011, beating all other sectors by a wide margin. The next best sector was consumer staples, down 6.9%. Every other sector posted doubled-digit declines, with financials the worst, down 31.1%, followed by materials, energy, and industrials.

“Under a prolonged kick-the-can down the road scenario similar to 2011, we suspect defensive sectors could be in a similar position this year,” Turnquist said in a research note. Investors should avoid small-caps altogether, Turnquist adds, as they have lagged the large-cap indexes for months and “are likely to underperform with a debt ceiling resolution, or without.”

Scoop up yields on short-term Treasuries and stick with cash.

Treasuries are supposed to be the ultimate safe haven in a storm. A fight over U.S. debt puts them in the eye of this storm and some short-term Treasuries have sold off, pushing up yields, which move inversely to prices.

Another sign of stress: Insurance on U.S. government debt—called credit default swaps—has roughly doubled over the past month, according to LPL, as investors demand a higher premium for default risk.

The bull case for Treasuries is that a default will ultimately be avoided. That could push yields on short-term notes back down and lift prices. Much may also depend on the contours of a deal and whether it’s interpreted as inflationary or restrains spending; the last scenario would be viewed favorably by the bond market.

In the near term, Michael Rosen, chief investment officer at Angeles Investments, with $40 billion in assets under management, says investors have an opportunity to pick up higher-yielding short-term Treasury bills. Four-week Treasury bills maturing May 30 yield 4.33% while those maturing June 1 yield 5.12%, Rosen notes.

The market is assuming that “when the calendar flips to June 1, that bill may not get paid on time,” he says. “I’d rather own that June 1 bill than the May 30 bill and pick up that nice yield.”

Rosen thinks the likelihood of investors receiving less than 100 cents on the dollar when Treasury bonds come due “is pretty close to zero.” Investors “may not get paid back exactly on time, but they will get paid back,” he adds.

Ken South, founder and CEO of Tower 68 Financial Advisors, a registered investment advisor in Newport Beach, Calif., also sees opportunities in short-term Treasuries. “Use shorter maturity, government-backed [bonds] to earn a nice return while waiting for the turmoil to subside,” he says.

One other investor who sees gains in short-term Treasuries is Bill Gross, Pimco’s former chief investment officer. He told Bloomberg Television the debt standoff was “ridiculous” and expects it to be resolved. For investors who are less concerned, like himself, he suggested buying one- and two-month Treasury bills “at a much higher rate” than what long-term bonds are yielding.

Money-market funds should weather the turmoil. The funds do hold short-term Treasuries and high-grade commercial debt, exposing them to volatile trading dynamics. But they are unlikely to lose much value given that the big banks and fund sponsors, including Vanguard and Fidelity, generally keep enough cash on hand to maintain a stable $1 net asset value, and the Fed would likely step in with stabilization measures in a bank-run scenario.


Important Disclosures: 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. 

Investing involves risks including possible loss of principal.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.