To The Moon

It was a “pleasant” surprise to wake in the morning to find that US market has staged a 1-day rally where gains were quite “substantial”.

As mentioned in my Tue, 16 May post’s opening paragrahs, “pointless” to celebrate because market will struggle thru this week, in a “confused” state.

See what I mean? US market’s futures for Thu, 18 May is a “red” wash all over again.

Without a national issue eg. Debt Limit, the US market is already “unpredictable” at times; let alone with one now, the US market is going to get even crazier.

While trying to play the devil’s advocate on the US Debt Limit issue, I stumbled upon the article by The Council of Economic Advisors (CEA) on the economic impact based on different degrees of Debt Limit fallout / meltdown.

For starters, CEA is an agency within the Executive Office of the US President.

It is charged with providing the President objective economic advice on the formulation of both domestic & international economic policy.

Post is dated 03 May 2023

CEA’s article has confirmed:

Historically even getting close to a breach of US debt ceiling could cause significant disruptions to the Financial markets.

This would then damage the economic conditions faced by Households and Businesses.

CEA has identified 3 possible impact scenarios:

• Brinksmanship: negotiations run up until 01 Jun deadline.

• Brief default: deadline is tripped but then resolved within a week.

• Protracted default: US fails to raise its borrowing levels for > a quarter. 

Damages based on (1) Short default & (2) Long drawn default

Impact On Govt. Debt Default:

(1) Economic gains erased (since President Biden took office):

• Near 50-year low unemployment rate.

• 12.6 Million jobs created thus far.

• Robust consumer spending. This which has consistently powered a solid, reliable growth engine, supported by paychecks from the strong job market and healthy household balance sheets.

(2) Interest Rates Will Skyrocket.

• Due to govt. inability to enact counter-cyclical measures in a breach-induced recession.

• Households and small businesses are left to fend for themselves by borrowing from private sector to tide over.

• To borrow during uncertain times implies that probability of default would be “high”.

• As such, risks engendered by possible-default would cause interest rates to skyrocket including interest rates on Treasury bonds, mortgages, and credit cards.

(3) Chaos In Financial Market

• Cost of insuring US debt has risen substantially (refer to above table).

• It is now at an all-time high, reflecting increased worries about a US default.

• Credit default swap (CDS) spreads—the insurance premiums that must be paid to insure US debt—started to increase dramatically in Apr 2023.

I find the CEA article is particularly informative as it gives unprecedented details on what to avoid should a default materializes (not that I am looking forward to one).

A “Default” means:

1. US govt fails to pay its obligations to (a) bondholders, (b) contractors, (c) beneficiaries and (d) other creditors.

2. “Failure to pay” would erode confidence in US dollar and Treasury securities, which are considered safe-haven assets.

3. Trigger higher interest rates, lower credit ratings, reduced liquidity, and increased volatility.

Investment Sectors To Avoid:

To me, top 3 sectors that are most dependent on government spending and borrowing.

• Industrials.

• Healthcare.

• Utilities.

If I have to tag a stock to sectors mentioned above, hmm.. it would be (I think) the followings because they have been supported by government contracts, subsidies, regulations, and guarantees that could effectively be jeopardized by a default:

• Industrials - $Lockheed Martin(LMT)$ . Largest US defense contractor with bulk of revenue from government contracts for weapons systems, aircrafts, satellites, and cybersecurity.

• Healthcare - $UnitedHealth(UNH)$ - Largest US health care provider that operates health insurance plans covering millions of Americans under (a) Medicare, (b) Medicaid, and (c) Obamacare.

• Utilities - $Duke(DUK)$ - One of the largest US electric utilities that generates & distributes electricity to millions of customers across several states that are regulated by federal and state agencies.

Above sectors and stocks-related to sectors are based on personal homework. It is my belief that they would be disadvantaged should a default occurs.

Similarly, it should not be mis-interpreted that in the event that the debt limit crisis is averted, the stocks mentioned will rally.

• Do you think the 2 parties will be able to avert the Debt Limit crisis ?

• Do you think the sectors mentioned will “suffer” the most in the event of a Default?

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