Don't Let DC Scare You... Get Defensive!

by: Christopher Lum Lee

With talks in DC about a government shutdown looming, I'm wondering how many people are taking these words seriously. I seriously believe that the only thing coming from DC is drama. I'm an investor who's grown apathetic towards any talks that come from DC- with the exception of tapering or any tax increases on dividends or capital gains. While a government shutdown could affect certain sectors of the market- and I'm thinking specifically of defense or aerospace- most sectors shouldn't be affected by the shutdown. For the purposes of this discussion, when I say 'the market', I'll be using the SPDR S&P 500 (NYSEARCA:SPY) as the measuring stick.

History is repeating itself here. In 2011, there was the first debt ceiling crisis, which gave the market some serious volatility in August and September. Out of this came the Budget Control Act of 2011, which brought about the 'fiscal cliff', which scared the market again. Because the fiscal cliff couldn't be avoided, then the American Taxpayer Relief Act of 2012 was signed into law on January 1, 2013. And here we are in September 2013 yet again dealing with another debt ceiling issue.

The bottom is that every time DC talks, the markets react in ways that it shouldn't have to!


A government shutdown would be highly publicized, which would essentially promote fear and uncertainty in the hearts and minds of investors, meaning right off the top we could see a drop in the SPY and the Dow Jones Industrial Average (NYSEARCA:DIA). Specific sectors that could be hit the most would be the aerospace and defense sector as reflected in the SPDR Industrials ETF (NYSEARCA:XLI). I expect that other sector ETFs may not be hit as much- and I say that because the market does react and companies that have no real reason to drop on news of a government shutdown do get hit.

Let's Not Forget About Tapering...

While tapering has been avoided for now, another round of discussions of tapering can take place anywhere between now and December, which means that all other investments such as bonds, emerging market equities, and the dollar will experience volatility as well. There is more than enough speculation and literature that will suggest different directions that these asset classes will go in once tapering does happen that it need not be repeated here, but the fact is that given the threat of the government shutdown, we also have to consider the impending tapering.

When Ben Bernanke spoke at the press conference that confirmed that tapering wasn't going to happen right now, he said that he has no supporting evidence to suggest that the economy is ready for tapering to happen. Let's face it, unemployment statistics, lower-than-estimated GDP, the devalued dollar, take whichever metric you feel best about and put them all together and we have our own cocktail of long-term reasons why we're not ready to taper.

Do Safety Plays Exist?

While the fear mongering in DC continues, the market is responding in tandem to DC. This makes some plays appear riskier or safer than others. While investment advisors and analysts speculate that some classes should be abandoned altogether, I think that each asset class could have its own diamond in the rough. Long-term investors will always run into some volatility in the market but the goal is preservation and growth of capital. It's time to get on the defensive.

Looking at stocks, I personally like stocks in defensive sectors or the defensive sectors themselves. Some of the defensive long positions that I hold that I've disclosed include Pfizer (NYSE:PFE), Coca-Cola (NYSE:KO), and Hawaiian Electric Industries (NYSE:HE). Other stocks I would consider in times like this would be Wal-Mart (NYSE:WMT), McDonald's (NYSE:MCD), or Johnson & Johnson (NYSE:JNJ). If you like sector ETFs, the SPDR Health Care ETF (NYSEARCA:XLV) or the SPDR Consumer Staples ETF (NYSEARCA:XLP). I feel that on a common sense basis, stability is demonstrated by the fact that despite economic and market factors, people still need things such as medications, food, water, and electricity, among other things.

The bond markets have a bit of stigma attached to it and have been beaten up over this year because of the 'great rotation' from bonds to stocks and now the fears of tapering and the rise of interest rates have scared people away. I still like bonds. I don't like U.S. Treasuries, period. I do like municipal bonds that have AAA bond ratings, although additional research would need to be put into finding out what that jurisdiction's debt load is. I believe that if a government jurisdiction is going to tout have a AAA bond rating, they can maintain that rating whether they issue $100 in bonds or $1T in bonds so long as they make good on their financial obligations. I only like corporate debt of companies that have a good track record in terms of credit rating and a good balance sheet and income statement. Recently, I've had my eye on the Managed High Yield Plus Fund (NYSE:HYF), a closed-end fund that invests in the various sectors in the U.S. Investors who are looking for corporate debt in the U.S. But also in the foreign markets, especially the emerging markets, may be interested in considering the Western Asset Global High Income Fund (NYSE:EHI). HYF is currently trading at $1.95 and yields $0.18/9.10% annually and EHI is currently trading at $12.13 and yields $1.16/9.80% annually.

Another investment idea is to look at precious metals. Gold (NYSEARCA:GLD) has had a run up and then down and is currently trading at $127.96- approximately 73.5% of its 52-week high of $174.07. I personally own physical silver, with the price reflected by the iShares ETF (NYSEARCA:SLV)- currently trading at $21.00 per share and at approximately 61.6% of its 52-week high of $34.08. The investment theory behind these two precious metals is that they are the ultimate hedges against inflation. I like silver more simply because of the fact that there's a finite amount in the world. Although I don't expect silver to run out anywhere in the near future, I still think that it's worth owning some of it as an insurance policy for my portfolio.

The Bottom Line...

The fact is that when DC talks, the market hurts. DC has some serious issues coming up that it will be forced in dealing with and it's being taken out on the markets and the investors. While it's unfortunate that the market reacts in ways that it shouldn't, it still does. Long-term investors looking to preserve and grow capital and try to come out ahead are forced to find new investment strategies that would work for them. Here, I've given my thoughts on a few investment ideas.

Disclosure: I am long EWA, HTA, HE, KO, MO, PFE, VZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.