The Sheer Idiocy Of Debt Ceiling Negotiations

Includes: SPY, UPRO
by: Macro Investor

As everyone knows, there is a lot of drama on the topic of the debt ceiling these days. As the story goes, the Government has hit the debt ceiling, and unless Congress votes to raise it, USA will go into default. The Republicans in the Congress, freshly bruised from the Fiscal Cliff crisis, have pledged to not raise the debt ceiling unless the Democrats agree to major spending cuts. The Democrats have dug in.

Of course, USA defaulting will have a huge negative effect on the global markets. A crash followed by a protracted Depression will be the likely result. So the markets are jittery. Some people are talking about introducing The Magic Trillion-Dollar Coin, a stupendously silly but perhaps needed idea.

We have seen this movie before. When the fiscal cliff discussions came along, the market would swing madly every day. Then, of course, an agreement was reached, and all was OK.

How will this new drama unfold? Are the Republicans truly going to dig in, or are they merely posturing? No reasonable person can read the news and claim that the Republicans are truly going to dig in and let the country default. Let's examine what a few heavy hitters on the Republican side have said.

First, a statement from the famous GOP strategist Karl Rove:

This New Year's Day he (Obama) tartly said, "We can't not pay bills that we've already incurred." Who is suggesting we don't? Not House Speaker John Boehner and Senate Minority Leader Mitch McConnell, or any other Republican leader. Quite the opposite. They want to cover the cost of the existing debt while cutting spending to prevent a fiscal catastrophe.

It is pretty clear that at least in Rove's mind there is no chance of not raising the debt ceiling. The Republicans want spending cuts but are not going to force the country into default. However, this means Republicans may have tipped their hand and the debt ceiling is no longer a negotiating chip for them.

Next, a statement from the House Speaker John Boehner:

The debt bill is "one point of leverage," Mr. Boehner says, but he also hedges, noting that it is "not the ultimate leverage." He says that Republicans won't back down from the so-called Boehner rule: that every dollar of raising the debt ceiling will require one dollar of spending cuts over the next 10 years. Rather than forcing a deal, the insistence may result in a series of monthly debt-ceiling increases.

This would have been hilarious if it wasn't so sad. We can't even get one debt ceiling increase in 18 months done properly, so it is unlikely that Congress will successfully do the same exercise once every month. Boehner clearly knows that this is not a point of leverage and the Republicans are not going to make the country default.

Finally, a statement from someone who has experience with Government shutdowns, ex-House Speaker and ex-Presidential hopeful, Newt Gingrich:

Former House Speaker Newt Gingrich (R-Ga.) warned House Republicans not to hold the debt ceiling for political leverage Friday, contradicting Republicans who have strongly hinted at their plans to do just that.

"They've got to find, in the House, a totally new strategy," he said on MSNBC's "Morning Joe." "Everybody's now talking about, 'Oh, here comes the debt ceiling.' I think that's, frankly, a dead loser. Because in the end, you know it's gonna happen. The whole national financial system is going to come in to Washington and on television, and say: 'Oh my God, this will be a gigantic heart attack, the entire economy of the world will collapse. You guys will be held responsible.' And they'll cave."

I think Mr. Gingrich said it so eloquently that no further explanation is needed from me. These three examples clearly show that we are not at any serious risk of a Government shutdown or default. USA will keep paying its bills on time, and the market should stop worrying.

However, the market being the drama queen that it is will likely start to drop in about 2-3 weeks, which will be the time to sell, and then buy back the week of the final negotiations, to get positioned for the relief rally. I personally plan to do just that.

So, what is the best way for investors to profit from this situation? I like high beta ETFs that are based on market indices. The high beta provides lots of leverage as the market has its mood swings and goes up and down, and the index provides a broad exposure so that investors do not have to worry about getting the punt wrong on a specific stock.

For trading purposes, I recommend the ProShares UltraPro S&P 500 ETF (NYSEARCA:UPRO). I plan to buy this ETF about 1 week before the debt ceiling crisis due date, and close the position right after the relief rally. For those less comfortable with volatility, a safer bet may be to use the core SPDR S&P 500 Trust ETF (NYSEARCA:SPY). This strategy yielded about 5% returns in a week during the fiscal cliff crisis.

This, however, has a lot of risk. If the Congress truly cannot come to an agreement, investors employing this strategy will be in for a lot of hurt. But as Democratic Representative Alcee Hastings said about the House Republicans during the fiscal cliff debate, I believe that

"They're crazy, but they're not that batshit crazy."

Disclaimer: This is not meant as investment advice. I do not have a crystal ball. I only have opinions, free at that. Before investing in any of the above-mentioned securities, investors should do their own research, consult their financial advisors, and make their own choice.

Disclosure: I am long UPRO. 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.