How Should Investors Prepare For A Debt Ceiling Crisis? (2024)

Time is running out for the Biden administration and Congress to reach a deal to raise the debt ceiling. Treasury Secretary Janet Yellen has said the U.S. could default as soon as June 1 if Congress doesn’t take action.

Aaron Brachman, managing director and wealth manager of the Washington Wealth Group team at Stewart Partners, says his clients are asking questions about the debt ceiling standoff.

“They’re worried about what might happen to the economy if the debt ceiling is not raised,” says Brachman.

The last time a hyper-partisan debate stalled efforts to raise the debt limit was in 2011. The delay damaged the economy, panicked the stock market, nearly pushed the country into default and led S&P Global to downgrade the U.S. sovereign credit rating.

Let’s take a closer look at different considerations for investors who want to know the best way to position their investment portfolios at this delicate moment.

Would a Debt Ceiling Crisis Be Bad for Markets?

First and foremost, it’s worth bearing in mind that the most likely outcome is a last-minute deal to raise the debt ceiling. But as the U.S. gets closer and closer to the line, you may be wondering what you should be doing with your investments to avoid potentially getting hurt.

“A broad spectrum default by the U.S. Treasury would trigger financial armageddon,” says Robert Michaud, chief investment officer at New Frontier Advisors. “This would mean a systemic drop in wealth of all individuals.”

You have options to play the debt ceiling standoff, say leading financial advisors. While the threat to markets and the economy is imminent, some stocks and market sectors are poised to benefit from economic crosscurrents right now. Others stand to benefit once the crisis is resolved.

“Imagine when stocks begin to break to new highs,” says Paul Schatz, president of Heritage Capital and treasurer of the National Association of Active Investment Managers (NAAIM). “You could see one of the all-time great short squeezes as bears throw in the towel and everyone plays catch up.”

A short squeeze happens when traders get stuck on the wrong side of a short selling play. They were betting that stocks would decline in price, and they get squeezed out when prices rise instead.

The risk of course is that the inevitable rally takes years rather than days or weeks to arrive.

Ways Investors Can Take Advantage of the Debt Ceiling Crisis

If you are a glass-half-full investor who’s willing to seize opportunities no matter what’s happening in the stock market, here are a few good ways to play the debt ceiling crisis, shared by the financial professionals we interviewed.

Let’s start with defense stocks. Chris McMahon, president of MFA Wealth and CEO of Aquinas Wealth Advisors, both in Pittsburgh, sees defense contractors benefitting from a deal to raise the debt limit.

“Defense companies stand to benefit as the government may need to increase defense spending as a result of the debt ceiling issues.”

We would note that the iShares U.S. Aerospace & Defense ETF (ITA) is the largest defense contractor exchange-traded fund. This $5.7 billion ETF offers targeted exposure to U.S. companies that manufacture commercial and military aircraft as well as other defense hardware. ITA owns stocks Raytheon Technologies (RTX) and Lockheed Martin (LMT).

The fund’s annual expense ratio is a relatively low 0.39%. Its total return over the 12 months ended May 12 was 15.54%—compare that to the 6.76% return for the S&P 500 Index over the same period.

Still, in the past month the fund is down 4.62% versus a gain of 0.91% for the big-cap bogey. Investors may be concerned about companies that depend largely on the U.S. government for revenues.

Should You Bet on Banks?

McMahon also believes that financial services stocks look like another sector that’s poised to be a potential beneficiary of a debt ceiling deal.

“The financial sector stands to benefit from debt ceiling issues because a rising debt limit could lead to increased borrowing by the government, which could lead to increased profits for banks and other financial institutions,” he says.

As for some investors’ concerns about regional banks, McMahon agrees. The lenders that are best positioned to benefit from increased government borrowing are mainly large, well-established national banks, he says. He added, “Regional banks hold a significant amount of T-Bills. And we have made the decision to divest from those banks in our portfolio.”

The Financial Select Sector SPDR Fund (XLF), a heavyweight ETF with $28.8 billion in total net assets, caught our eye. XLF is part of the State Street Global Advisors’ stable of funds. After a very rough patch for the banks, XLF’s total return in the past 12 months is down 1.44%.

U.S. Treasury Securities May Be Worth a Look

Still, financial services remain fraught with risk. For another advisor we spoke with, this means steering clear of banks.

“Banks hold significant amounts of U.S. Treasury bonds and other government debt,” says Derek Miser, investment advisor and CEO at Miser Wealth Partners. “A default could cause a sharp decline in the value of these assets.”

Declines of a similar nature brought down regional banks Silicon Valley Bank, Signature Bank and First Republic. But Michaud points to the silver lining offered by U.S. Treasury securities.

“Treasurys paradoxically can perform well, since even when faced with potential default, they remain the relatively safest asset,” he said.

Concurring, Brachman says that “Treasurys will be the safe haven of last resort.”

If you want to play long-term Treasurys, consider the iShares 20+ Year Treasury Bond ETF (TLT). With $36 billion in assets, it is the jumbo of its space. Its expense ratio is a low 0.15%. Its dividend yield is a decent 2.70%.

Just keep in mind that TLT’s one-year return of negative 8.53% reflects the beating that long bonds have taken while the Federal Reserve has been raising interest rates.

Gold: The Traditional Safe Haven

Precious metals like gold may benefit from a U.S. default, says Miser. There are plenty of gold stocks and funds you can choose from to invest in this traditional safe haven investment asset.

“Gold and other precious metals have traditionally been viewed as safe haven investments during times of economic turmoil,” he says. “If the debt ceiling is not raised and the government defaults on its debt obligations, investors may turn to gold and other precious metals to protect their wealth.”

The largest precious metals ETF is SPDR Gold Shares (GLD), with $60.7 billion in net assets. Its annual expense ratio is 0.40%. Dividend yield is zero, however, as gold notoriously lacks much in the way of cash flow.

Nevertheless, the fund’s total return ranks in the top 10% of its Morningstar commodities fund peer group over the past 15 years and the top 13% over the past 10 years.

Take Refuge With Utilities

Utilities stocks are another traditional safe haven. When the economy stumbles, consumers don’t turn off their lights, stop watching television and unplug the refrigerator.

Michaud likes utilities in a scenario where economic volatility increases as Congress prolongs the debt ceiling crisis by failing to suspend or raise the debt limit.

The Utilities Select Sector SPDR ETF (XLU) is the big candle in the utilities ETF space, with its $16.2 billion size. It has a very low glare annual expense ratio of 0.10%. Its dividend yield is a high wattage 3.01%. Its return over the past year is negative 1.63%. But its 10-year average annual gain is 9.00%. And the fund outperformed 93% of its peers over the past 10 years.

Likewise, Sam Stovall, chief investment strategist for CFRA Research, says utilities is one of the sectors he likes amid “concern over the possible debt default, combined with the market’s traditionally poor seasonal performance from May through October.”

Stovall likes Edison International (EIX), an S&P 500 stock with a five-star strong buy recommendation from CFRA. Currently trading around $71, Stovall says it can hit $88 within six to 12 months.