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There’s going to be a massive stock and bond market selloff in the first half of 2011.

Not only that, the selloff could cause a worldwide financial disaster, global market crashes and the destruction of wealth that will make the popping of the dotcom and housing bubbles feel like a mild inconvenience.

Why?

Because, quite simply, America is playing a dangerous game of “chicken” with its national debt. And the ramifications are extraordinary. I’m going to explain the situation and give you three ways to protect yourself from this mess before it’s too late…

Debt Doomsday: Coming in May 2011

America’s debt ceiling currently stands at $14.3 trillion. This is the level that, by law, the government’s debt is not allowed to exceed.

Trouble is, the government’s present debt has swelled to $13.7 trillion.

This means that at the current rate, we’re on course to smash through that $14.3 trillion ceiling around May 2011 (although it might happen a month or two later, depending on what budget cuts are enacted in the next few months and how quickly they’re implemented).

So what will the government do about this? Same thing it’s done almost every year since 1962: Raise the debt ceiling so America can pay its bills.

Congress really has no choice in the matter either. If the ceiling isn’t raised, we’ve got a problem. A very big one.

A Fistful of Dominos

Without Congressional approval for additional debt, the U.S government cannot pay its bills – most notably, interest payments on treasury bonds, bills and notes.

If America defaults on those payments, or even misses them by just one day, the domino effect would be brutal…

  • Domino #1: The country would lose its AAA credit rating and those bonds, bills and notes would no longer enjoy their status as the safest investments on the planet.
  • Domino #2: In turn, a lower credit rating would mean that the United States would pay higher interest on its bonds in order to attract investors. Result?
  • Domino #3: A tidal wave of selling through fixed income markets, driving interest rates higher still.
  • Domino #4: Social Security would be hit hard, as its funds are invested in Treasuries. Suddenly, Social Security would have far less resources than just a day or two earlier.
  • Domino #5: If money is pouring out of so-called “safe” investments, you can bet that in that kind of environment, the demand for riskier investments would be next to nil. Stocks and financial markets around the globe would plummet.

So why is this year’s Congressional raising of the debt limit different than every other?

To Raise or Not to Raise?

Simple: This year, some members of Congress have said they won’t vote to raise the debt ceiling. And they may be serious this time.

Earlier this year, 38 Republican Senators voted against raising the ceiling. However, they did so, knowing full well that they’d be outvoted and that the limit would be raised despite their “objections.” That way, they could return to their Congressional districts, claiming some semblance of fiscal responsibility.

Their vote didn’t matter so much back then… but with the Republicans having wrestled control of the House of Representatives last week, it sure does now.

It throws up an interesting dilemma. The Republicans – and particularly the Tea Party candidates who ran on a platform of cutting spending and the deficit – will have a very difficult choice to make. Either go back on their word and vote for an increase in the debt ceiling, or vote against it and run the risk of financial calamity.

It’s still early, but some Senators are already threatening to vote “no.”

  • Senator-elect Rand Paul of Kentucky has indicated that he won’t vote in favor of raising the debt ceiling.
  • South Carolina Senator Jim DeMint said he won’t vote to raise the limit unless it’s combined with some plan to balance the budget, return to 2008 spending levels and repeal President Obama’s healthcare plan.
  • When asked if he’d vote against a debt ceiling increase, even if it leads to a government shutdown, Utah Senator-elect Mike Lee answered, “It’s an inconvenience. It would be frustrating to many people and it’s not a great thing, yet at the same time, it’s not something we can rule out.”
  • And Republican National Committee Chairman Michael Steele told CNN, “We’re not going to compromise on raising more debt or the debt ceiling.”

This may be a dangerous political strategy…

History Repeating? Not Likely…

In 1995, the Republicans threatened President Clinton with shutting down the government if he didn’t agree to their budget. Clinton vowed that he’d never agree to it, even if his approval rating fell to 5%.

He won, too. The government did in fact shut down and the Republicans were the focal point of America’s anger. President Clinton’s approval numbers actually went up.

Flash forward to today. President Obama is likely aware of this history. And while he may be willing to negotiate on spending cuts, he will not repeal healthcare reform, which is the hallmark of his Presidency.

For Obama, though, the situation in 2011 will be much worse than it was for Clinton in 1995. I’m talking about a meltdown in the stock and bond markets.

Bill Busting… Washington Style

Bruce Bartlett, a former advisor to President Reagan and deputy assistant secretary for economic policy at the Treasury Department under President George H.W. Bush, recently stated, “You introduce even the tiniest little bit of doubt into the minds of ultra-conservative investors and that’s potentially disastrous. It hurts our ability to raise money without a risk premium.”

Representative John Boehner, the new Speaker of the House, appears to be more realistic than his colleagues in the Senate. He’s indicated that he’d vote for raising the debt ceiling as long as it accompanies spending reductions.

The bottom line, though, is this: The Senate likely doesn’t have the votes to defeat a bill to raise the debt ceiling, while the House does.

And in the end, it doesn’t matter. The bill doesn’t have to be defeated. A filibuster accomplishes the same thing. Don’t forget, this bill must be passed by the date we hit the ceiling, otherwise the government goes into default. It’s not something that can be put off until later.

So, in fact, a filibuster is even more powerful than a “no” vote. And the mere threat of a filibuster could spook investors badly enough to sell first and ask questions later.

You need to go about protecting yourself as soon as possible…

Protect Yourself From America’s Debt Showdown

There are a few investments that will likely do well in the chaotic environment I just described…

  • Gold: The resilient yellow metal should soar as the U.S. dollar sinks and investors flee to safety. If you don’t want to own the metal itself, you can buy the SPDR Gold Shares Trust (NYSE: GLD) ETF, which serves as a close proxy to the price of gold bullion.
  • Short Treasuries (Option 1): Consider the ProShares Short 20+ Year Treasury (NYSE: TBF), which aims for a 100% inverse correlation to the Barclays 20+ Year U.S. Treasury Bond Index.
  • Short Treasuries (Option 2): If you’re a more aggressive investor, take a look at the ProShares UltraShort 20+ Year Treasury (NYSE: TBT). It seeks to obtain results that are double the inverse daily performance of the Barclays 20+ Year U.S. Treasury Bond Index. So if the index falls 10%, the ETF should gain about 20%.

Remember: From most crises comes opportunity. Investors who are agile and aware of the potential debt ceiling landmine can grab profits by getting into the right investments at the right time.

Additionally, the ensuing volatility may create buying opportunities for some of your favorite stocks, so be sure to put together a watchlist of stocks you’re interested in owning at lower prices.

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Source: How to Protect Yourself From the Crash of 2011