As the US moved one day closer to defaulting on its debt for the first time in its 225-year history, Wall Street is starting to brace for Armageddon.
While few money managers believe Uncle Sam will actually not pay its bills, no one wants to be left entirely unprepared – so they are starting to act.
Some, fearing whopping double-digit declines in the stock market should debt-ceiling increase talks go to the wire, are slowly moving assets out of stocks and into cash.
Institutional investors tell The Post they are slowly switching money from equities to long-date Treasuries, short bets on the S&P 500 or reverse ETFs.
“Clearly, Washington is dysfunctional, and the markets know that,” said Martin Leclerc, chief investment officer of Barrack Yard Advisors. “But the debt-ceiling thing is beyond the pale. It is completely bizarre that anyone in Congress would be so reckless that they would endanger the credit of the US.”
Memories of the 2008 financial crisis – which took almost 50 percent off the markets before starting a comeback six months later – are still fresh in investors’ memories.
They’ve even begun to talk about “black swan” events and tail risk funds again.
On Tuesday, with the end to the debt ceiling drama nowhere in sight, the Dow Jones industrial average fell 159.71 points, or 1 percent, to close at 14,776 – for a total decline of 5.7 percent since its Sept. 18 high.
The S&P 500 Index fell 1.2 percent on Tuesday, to 1,655.45, 4.0 percent off its high.
But the worst is yet to come.
Market watchers said that 10 percent could come off before Oct. 17, the day that the US government said it will run out of money to pay its bills. If the default happens, a bear market dwarfing that of 2008 could be in the cards.
Frank Curzio, a financial research analyst for Stansberry Research, said buying Treasuries may not be the smartest move.
“The best way to play this is reverse ETFs,” he said. A reverse ETF on the S&P 500 will go up 2 percent if the S&P goes down 2 percent.
The International Monetary Fund weighed in on Tuesday, cutting its forecast for global growth to 2.9 percent as a result of the shutdown.
That number doesn’t factor in a stalemate that would cause a default, which it said “could seriously damage the global economy.”
President Obama said a default would create “a significant risk of a very deep recession.”
To prepare, Leclerc said he is more than 20 percent in cash now. “We could see a 10 percent drop in the market” if the government stays closed until Oct. 17, he said, but a default “could be 2008 all over again. It will be unprecedented territory.”
Fears of default could create opportunities for the Cassandras of the hedge-fund world who run “black swan” or “tail risk” funds designed to prosper in doomsday scenarios.