Debt Ceiling Jitters

We're either in or rapidly approaching a federal debt crisis as the so-called ex-date when the government runs out of money is just over two weeks away now. With the default something most everyone agrees would be a catastrophe. And there are some indications in the T-bill and the CDS markets that at least some investors are starting to get worried. But you couldn't really tell that from the equity markets. This is not the first time we have been here. And we asked our colleague Michael McKee to compare what we're seeing now with what we saw in 2011 when we had a similar close brush with disaster. Investors David would rather hope that history doesn't repeat or rhyme for some time we've been told that nothing's going to happen on the debt ceiling until we get to the last minute or until Wall Street melts down.

And it does seem we're getting close on both counts. Here's what J.P. Morgan Chase CEO Jamie Dimon told us just a few days ago. Full default. That is potentially catastrophic. And you can go through a million ways and but everyone anyone knows that's catastrophic.

And I don't think it's going to happen because it gets catastrophic. And the closer you get to it you will have panic. Markets get volatile. Maybe the stock market go down. The Treasury markets will have their own problems. It's amazing. You already have certain T bills trading 3 percent and right next to 5 percent.

This is not good. We have seen this movie before the debt ceiling taken hostage for spending cuts a number of times over the past couple of decades. 2011 is one time when investors don't want history to rhyme. They went down to the wire as President Obama fought the idea of giving into extortion on the debt ceiling. Then markets collapsed. The S&P 500 went down about 20 percent and stayed down for quite some time before starting to go back up again. Why aren't we seeing more reaction equity markets than we have so far to the debt ceiling.

I hope it's not just complacency and a correct assumption that although the can will probably inevitably kick to the 11th hour 59 minute that's just the way things are done particularly on this subject. But so my guess is just complacency and an assumption that something will get done. I'd hate to think we have to go down the same path of 2011 which is also a kin for different reasons of what happened in 2008 with ultimately the passage of tarp. You needed that riot moment in markets. I think I agree with Jamie Diamond. I think it would be cataclysmic. I don't think anybody should be cavalier about letting it happen.

Whether it's for political gain or whatever reason my concern with regard to 2011 macro conditions are very different. We were on an upswing in the economy having come out of the global financial crisis. We weren't dealing with an inflation problem or having come out of the most aggressive tightening cycle in 40 years. And then there's certainly more vitriol right now. So I think we all should be worried about it. But I think ultimately something will get done. Chris Luzanne quite correctly says the macro economic conditions are different.

Also I wonder if the conditions of the markets are different. That is to say we gave up a lot in the S&P 500 last year as I recall. Exactly. So we actually saw the massive decline in the S&P 500 last year. So a lot of the equity market risk was priced in last year. I think the interesting thing in terms of why are we not seeing volatility. Why are we not seeing movement in the equity markets.

Is the fact that you have to look at how investors are positioned. So what happened on the back of last year. A lot of investors moved money into money market funds into T bills into cash and cash equivalents. So the under positioning that we're seeing in terms of being long risk assets is also creating this muted volatility environment which in our opinion if you are someone who has exposure this idea that volatility is relatively low. What it means is that you can actually protect your portfolio. So in terms of portfolio hedging this creates a really unique opportunity to say if I think volatility is going to be higher going forward whether that's because of the Fed's trajectory whether it's because of the debt ceiling whether it's because of the credit crunch that we could see on the horizon by some protection to then be able to stay invested over the next couple of months. Listen what about that point.

Would you be advising investors to really take into account the possibility of debt failure or is it something you even can take an account given how unpredictable it is. Well yeah I think Chris is right in terms of doing some volatility hedging. There might be certain things that are specific to your own portfolio in terms of hedging whatever outsized positions. One of the things we've been emphasizing and it's not just tied to uncertainty with regard to the debt ceiling. It's every other category of uncertainty right now is within the equity portfolio. Avoid the concentration risk which we already talked about but also stay way up in quality. Take advantage of what's sort of lacking in the macro environment and look for companies that have interest coverage.

They have strong balance sheet high cash low debt. They've got positive earnings revisions positive earnings surprise lower volatility lower beta and that's I think the best way to navigate within the equity portion versus going out the risk spectrum too much.

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