COLUMN-Circuit breakers investors can use for a debt default

Mon Oct 7, 2013 2:20pm EDT
Email This Article |
Share This Article
  • Facebook
  • LinkedIn
  • Twitter
| Print This Article | Single Page
[-] Text [+]

By John Wasik

CHICAGO Oct 7 (Reuters) - In times of calamity, every portfolio needs a set of circuit breakers.

And, as Congress speeds toward the debt-ceiling barrier, it is a good idea to consider some inverse exchange-traded funds(ETFs) that move in the opposite direction of stock and bond indexes.

The first major hurdle is Oct. 17, when the Treasury will need authority to sell more debt securities - or face default on its obligations. What if markets get spooked over Washington's inability to reach a consensus on fiscal matters? If traders truly believe that Congress won't issue more debt to pay bills it has already racked up, that will send interest rates on Treasury paper soaring.

You can hedge political risk a number of ways with inverse ETFs. One worth considering is the ProShares Short 7-10 Treasury ETF, which gains if Treasury bond yields rise (and prices drop). During the past year through Oct. 4, the fund rose 2.4 percent, compared with a negative 1.7 percent return for the Barclays U.S. Aggregate Bond Total Return Index, a proxy for the U.S. bond market. The fund charges 0.95 percent for annual expenses.

Of course, a debt-ceiling duel would do much more than depress bond prices and the damage the faith in the credit of the U.S. government. It would severely cripple the U.S. economy at large. Government would have to cut spending by at least one-third. That means everyone from defense contractors to Social Security recipients would have to wait for their checks. Another recession could be triggered.

Jack Ablin, chief investment officer of BMO Private Bank in Chicago, puts it bluntly in a recent analysis: "While eventually business as usual will be restored and the stock market will ultimately recover, closing down 18 percent of our economy will leave a mark. Defaulting on Treasury obligations would foist the nation into a financial tailspin."

The stock market would eventually feel this pain most acutely. One way of hedging against that is the all-purpose bear ETF, the Direxion Daily Total Market Bear 1X ETF. It tracks the reverse performance of the MSCI U.S. Broad Market Index, and charges 0.67 percent of assets annually. Since U.S. stocks as measured by the S&P 500 Index are having a good year - up 16 percent through Oct. 4 - the bear fund is down nearly 19 percent through Oct. 4.   Continued...