Bearish and Bullish Plays on Debt Ceiling Bluster

by: Benzinga

By John Thorpe

While Republicans and Democrats take turns blowing smoke out their rears, Wall Street and the rest of civilized world has been trying to figure out what, if anything, Washington plans to do to stave off world-wide financial ruin. So far, the tea party leaves show one thing: no one has any idea, and some are more hopeful than others.

On the one hand, Liz Ann Sonders, chief investment strategist at Charles Schwab, is pretty certain that the debt crisis is overblown and that things are, and will be, just fine. Seriously.

Sonders believes, quite fervently, that Washington will come to its senses and pass a debt ceiling hike, calming the markets. She also laughs off the possibility of another recession. Instead, Sonders points to the giant growth anticipated in earnings for 2012 and argues that the most likely outcome is a recovering economy making a bullish run in stocks.

On the other side of this equation are a series of experts worried about the debt ceiling crisis, including some who do not see an easy solution emerging in the next few days. The crisis has already damaged the economy, they say, and will continue to do so as long as this debacle plays itself out.

"Growing uncertainty about the ultimate outcome inevitably has some negative effect on business capital investment and hiring as the August 2 deadline approaches," said David Crowe of the National Association of Home Builders.

This effect, experts say, will grow if the United States actually defaults on its obligations. The default would be worse than just increasing the interest rates across the board and the total amount of debt due. If we ended up missing Social Security payments, insurance payments to doctors, military pay, contractor pay, and so on, the results for the demand end of the economy.

Imagine, suddenly, all the mentioned groups suddenly missing a paycheck or two. Does anyone really think that wouldn't have an effect on consumer spending? Does anyone think that shock to consumer spending wouldn't have a detrimental effect on the economy. And, for the love of Zeus, we're barely out of the last recession. Some say we never really left the recession, despite formally, academically exiting it. Could the economy stand another dip south?

Luckily for traders of both mindsets, there are trades available no matter what you're thinking.

Trading Ideas


  • If the debt ceiling drama does blow over, do not be surprised to see the markets hit new highs in short order. Bullish investors should buy riskier sector ETFs, such as Energy Select Sector SPDR (NYSEARCA:XLE), Technology Select Sector SPDR (NYSEARCA:XLK), and SPDR S&P Retail (NYSEARCA:XRT).
  • For the most part, economists agree that if there is not a prolonged battle over the debt ceiling and a deal gets done, there will likely be little effect on GDP. In fact, a large debt deal could catalyze the stock market. In this case, investors might want to consider industrial names to capitalize on the global growth theme. Stocks such as Caterpillar (NYSE:CAT), Deere (NYSE:DE), Joy Global (JOYG), Potash (NYSE:POT), and Freeport-McMoran (NYSE:FCX) will do well if the market hits new highs in the wake of a deal.


  • An argument could be made that the market continues to be way too complacent in the face of the debt problems in the U.S. and Europe. Traders are not preparing for the worst case scenario. Contrarian investors should consider buying protection through VIX futures or the IPATH SP 500 VIX SHORT TERM FUT WTF, (NYSEARCA:VXX).
  • Economists believe that if the debt ceiling is not raised, and checks for Social Security, federal employees, and other Americans dependent on government do not go out, it could push the economy into another recession. In such a case, the stock market will undoubtedly get crushed. Inverse ETFs such as (NYSEARCA:QID), (BGZ), and (NYSEARCA:TZA) could do well in such an environment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.