The Market Gains Since The Lehman Collapse May Fall Victim To Politics; In This Case CYA Means Cover Your Assets

Oct. 7.13 | About: ProShares UltraShort (SDS)

Bloomberg ran an article recently making the point that a debt default makes the Lehman failure look trivial. I think it is right. The S&P 500 double inverse ETF (NYSEARCA:SDS) may be worth considering.

The stand off over the debt ceiling is similar to the cold war build up of nuclear weapons. Each side knows that the use of nuclear weapons will have horrible consequences yet each feels it necessary to have the arsenal as a "deterrent" to the other side using them. Neither side believes the other side will ever use them, but still sees the need.

In the Cuban Missile Crisis incident, Kennedy came close and the Russians blinked. Kennedy understood how important it was to stem the proliferation of nuclear weapons so close to the mainland U.S. and the Russians understood he was not going to back down. It is not clear what would have happened if the Russians had not backed down and negotiated the removal of missiles from Cuba in return for the U.S. removing its missiles from Turkey. In any event, order was restored and disaster avoided. Moreover, in the eyes of many historians, the United States "won."

Here we have a deadlocked U.S. government. The Republicans have taken a strong stand that they will not approve an increase in the debt limit unless the White House agrees to negotiate a number of items unrelated to the debt except in the most tangential way, including and particularly the terms and implementation of "Obamacare." I would call it the "Affordable Care Act" but that would lose some of its repugnance to readers, since most Americans are in favour of the "Affordable Care Act" but against "Obamacare" even though they are one and the same. Jimmy Kimmel did a commendable job of reporting this phenomenon through street interviews. The White House is adamant these are separate and distinct issues and refused to negotiate "with a gun to its head."

Like Kennedy, President Obama understands that allowing the debt limit to be used as a weapon to undermine currently enacted legislation on healthcare is a parallel to letting Russia build missile silos a few miles from United States soil. In this case national defense is not the issue but the role of President is at stake.

Neither side believes the other side will go the distance, and each waits for the other side to "blink." There is the danger. As the positions get more entrenched the first to blink will lose enormous political capital and some related careers will be damaged. And why "blink" if you are certain the other side will never allow the situation to go critical.

Emotions and egos are responsible for as much harm in the world as organized religion was in the Crusades of the Middle Ages. The psychology of "I am right and you must bend to my will" or suffer some disastrous consequence has caused wars, broken marriages, seen thousands tortured and killed and done untold harm over centuries.

Here it is the world economy at stake.

In my view, the Republicans should get over the fact that they do not have a member in the White House and stop trying to use every lever they can to compel a roll back of legislation passed by both houses. At some point, once legislation is enacted, it should surely be the duty of all parts of government to turn to execution of the Act rather than attempting to destroy it. The uncertainty the fight creates is destructive to business, individual planning and economic growth. Leadership cannot be achieved by being "against" something. It necessitates being "for" something. In parliamentary democracies, those against are the "opposition."

The stand off is Russian roulette with everyone's well being. Stop it. If you want to change Obamacare, do it in the way governments are supposed to behave. Introduce a bill that deals with healthcare and try to get it passed. It speaks volumes that the Republican Party thinks it needs to use the government debt ceiling to get its way. It is clear that without extortion as a tool, they believe they would fail to persuade both the electorate and their colleagues in Congress and the Senate of their point of view and pass the necessary bills. They look weak, more like school yard bullies than leaders. Their conduct is shameful.

While I am not a big fan of the policies of the current administration, it is right not to negotiate peripheral issues when dealing with the debt issue. If the President is the one who blinks, the integrity of the American system of government is weakened. What point is there to being President if the legislation you are successful in enacting becomes victim to either party refusing to fund the very acts they put into law and is held hostage to the next round of funding issues?

Regardless of who blinks first the stand off is damaging to the economy and a threat to the markets. In the short term investors should keep some cash in reserve, have a short book and own some puts. This will end, but it may not end well and it could be a precursor for many more similarly destructive confrontations. In their zeal to protect the "1 percenters" who populate the Republican party and want to avoid the economic costs of social justice, the Republicans may precipitate a market decline that is far more costly to their establishment supporters. It won't be the first time nor likely the last. What goes around comes around.

There is a lot of bullish sentiment around and much of it is well founded. But there are major risks. Prudent portfolios insure against that risk through short positions, puts and keeping a cash balance. I don't usually consider leveraged ETFs but given the short-term nature of the debt ceiling issue it might make sense to be long SDS.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SDS over the next 72 hours. 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.