Investing

Debt Ceiling Market Crash Entirely Possible: What to Do Now If It Actually Happens

Lee Jackson

Published: May 24, 2023 8:15 am

The “buy the dip” financial news teleprompter readers and the 30-year-old portfolio managers that have never seen a market crash are suddenly very silent and increasingly cannot be found. Market veterans and “hey boomer” professionals have seen this show before.

Back in 1987, the Dow Jones industrial average plunged a stunning 22% in one day. The equivalent today would be a drop on the venerable index of almost 7,300 points. During the period from 1929 to 1932, the stock market plummeted a stunning 83% and many people lost everything. That debacle caused the Great Depression, which really only ended when we entered World War II in 1941.

From 2007 to 2009, during the height of the mortgage and real estate collapse, one that brought us dangerously close to another depression, the market dropped a huge 57%. When stocks finally bottomed at an ominous intraday low of 666 on the S&P 500 on March 9, 2009, we put in the floor for the longest bull market in history. That bull market ended in January of 2022.

So where do we stand now? Very possibly on the precipice of a much larger decline than what we saw last year if the debt ceiling negotiations are not concluded and voted on by Friday. With the potential for more rate hikes coming (Federal Reserve President Bullard said another two increases could be forthcoming), we could be set up for a massive sell-off if there is indeed a debt default.

One positive for investors is that, for the most part, consumers and businesses are in reasonably good financial shape. Stock portfolios and home prices have increased dramatically over the past few years, and the financial system is not teetering on the abyss as it was globally in 2008 when Bear Stearns and Lehman Brothers collapsed and Merrill Lynch had to be bought by Bank of America at the last minute to avoid a similar fate.

One thing is for sure, the path of least resistance will be down if the debt ceiling is breached. There are some important items for investors to consider now, as they may have to prepare for the worst.

Do not continue trying to catch the proverbial falling knife. Instead, it may make sense to match current losses against gains, even if they are short-term in nature, to help build up a cash supply. The dry powder may come in handy down the road.

Immediately, if at all possible, close out any positions on margin. For individual investors to use margin loans to buy more stock is a bad plan when times are good, especially when those margin positions are high-volatility momentum stocks.

As we have recommended for years at 24/7 Wall St. a position in gold helps to mitigate the downside. As we noted recently, the precious metal could be going back to all-time highs, and going there soon.

Make sure that all the dividend-paying stock and mutual funds in personal and retirement accounts are coded to reinvest all capital gains and dividends. This allows you to buy more shares when prices are hit hard. The first quarter is about to end, and many stocks and funds pay dividends on a calendar quarterly basis.

If you have the good fortune to come into a windfall, like an inheritance or something similar, think about real estate. While mortgage rates have increased over the past year, the 30-year fixed rate has risen as high as 7.25% but has fallen back to 7.05% (for a 30-year FHA mortgage). That is still reasonable on a historic basis, though it is the highest since 2008. Owning cash-generating rental property is an idea that makes sense now.

If you do need to look for stock ideas, look at extremely conservative ones that are not affected as badly by even the worst-case scenarios. In other words, seek companies that provide goods and services that are needed all of the time, like utilities, telecommunications companies, consumer staples and real estate investment trusts.

Sell high-volatility stocks and look at the short end of the Treasury market. The two-year note, like all Treasury debt, is guaranteed by the full faith and credit of the United States and yields a stunning 4.32%. One-year certificates of deposit yield as high as 5.25% as well, and money market savings accounts, which are FDIC insured up to $250,000, yield anywhere from 3.75% to 4.50% with daily liquidity.

The 13-year bull market was a blessing and now may end up being a curse. There were numerous drops and corrections along the way. The fourth quarter of 2018 was a good example, when over a three-month period the S&P 500 declined 18% on an intraday trading basis. Last year was the worst year for the stock market since 2008. While 2023 has been much better, especially the tech-heavy Nasdaq, a precipitous drop is becoming increasingly possible.

Remember that even the most difficult events in human history and investing eventually have been overcome. Whether it be health-care-related, war-related, foreign geopolitical or domestic troubles, or any other issues that have combined to cause market sell-offs. With COVID-19 in the rearview mirror, the economy is in reasonably good shape, at least for now. And with the Federal Reserve finally doing what it should have done when it started raising rates in 2018, at least some of the carnage is closer to an end. However, the rally this year, especially for the Nasdaq, was likely of the bear market variety. Some feel it could be headed for a 20% or greater drop, with or without a default. So, it makes sense to take advantage of the recent increase in stock prices and shift to higher and safer ground.