The August 2nd deadline for increasing the debt ceiling is fast approaching. If the debt ceiling is not increased, the US will be in unchartered territory. The US government taxes and borrows to fund its operations. With the ability to borrow abruptly stopped, it is possible that some checks such as Social Security, Medicare, Medicaid, and unemployment compensation will not be paid. Even if the debt ceiling is raised the rating agencies will most likely downgrade US government bonds from AAA to AA. Ultimately, the US government will pay its obligations but the damage to the US credit rating has already been done. As a result of the political theater we have witnessed in the pass few weeks, US debt will be downgraded for the first time in history.
What should people do? It is difficult to know what, if anything, should be done. A few weeks ago, I wrote about Extended Duration Treasuries. I recommended that those who want a hedge against a market downturn should consider holding an ETF such as EDV which is made up of long-term treasuries. Ironically, these US government obligations, are likely to go up in times like these. When treasuries were considered default free (that is what a AAA rating means) investors rush to them as the last resort to safety. Many wonder if the downgrade will affect the “safe haven” status. I think not. There are no alternatives. The Euro denominated debt is riskier and gold if very hard to asses especially at the current peak price at more than $1,600 per ounce. Last week the market dropped by close to 4%. By contrast, EDV moved up by 3.32%.
I am not suggesting that investors should rush and purchase treasuries in large amounts because of what might happen next week or next month. We believe that investors should have a long-term view and not react to market movements on a short-term basis. Investors who have not built a diversified portfolio should read the investing section of this blog, and build a portfolio tailored to their needs. Within an investor’s portfolio, funds like EDV can play an important role as a hedge against market downturns. At least while there is no alternative US treasuries.