Great Debt Divide Extends to Bulls and Bears

The current debt debate divides not only Democrats from Republicans, but also bulls from bears.

The only common ground so far is Wall Streets expectation that some form of resolution will be reached to avert defaulting on the national debt, though avoiding a debt downgrade seems much less certain.

Its kind of like the NFL, there is just way too much at stake for either side to walk away, says John Glasmann,  managing director of equity trading at Pacific American Securities, likening the debt crisis to the just-ended NFL lockout.

Individual investors may feel like football fans did during the lockout -- confined to the sidelines with no say in the outcome. But investors have more at stake than missing their weekly gridiron games.

Politics is a dirty business sometimes, and the parties unfortunately are playing with peoples fears and their account balances, says Sean OHara, president of Revenue Shares.

I think folks are sort of paralyzed, like watching an accident on the side of the road.

The indecision is understandable given the volatility and losses many investors incurred during the financial crisis and subsequent sluggish rebound.

After all, the U.S. dollar and treasuries have served as havens in times of stress, including the aforementioned 2008 crisis.

But if the US were to default on its debt, or have its pristine 'AAA' credit rating taken away, its unclear if those investments will provide the same semblance of safety.

Ratings firm Standard & Poors has warned that it may downgrade the U.S. within 90 days of any debt deal if Congress does not offer a credible plan to get the nations fiscal house in order.

Several Wall Street firms including BofA Merrill Lynch (NYSE:BAC), Barclays Capital (NYSE:BCS), and Deutsche Bank (NYSE:DB) are indeed forecasting a debt downgrade.

In a note to clients, BofA Merrill Lynch strategists predict a stopgap deal will be reached on raising the debt ceiling, allowing the U.S. Treasury to keep making payments.

But the research note says any deal will fail to provide a credible long-term fiscal solution and likely results in a U.S. credit rating cut to AA by year-end or early next year.

Even if S&P follows through with a downgrade, all three firms advise sticking with stocks and U.S. Treasurys.

We dont expect big moves in any market, Steve Johnson, U.S. Chief Investment Officer for DB Advisors said on a conference call with journalists. The Deutsche Bank unit manages more than $250 billion in fixed-income assets worldwide.

Johnson adds, Even with a downgrade, I dont see the treasury market losing its haven status.  Were reasonably comfortable with the creditworthiness of the U.S. government.

Individual investors are less certain about the debt situation and how to position their portfolio. We have gotten a number of calls, says Rich Zito, partner and co-founder at Flynn Zito Capital Management. "Were not recommending people make wholesale changes."

While Zito has recommended clients stay in equities, he advocates locking in profits from riskier assets such as mid-cap growth stocks which have had made huge gains since the March 2009 lows. Out of the crisis there was a dash for trash. Well take some profits from the most aggressive positions; take some of the risk off the table without getting too conservative.

Rex Macey, director of equity management at Wilmington Trust agrees that now is not a time to sell stocks:  Individuals are gunshy from the financial crisis, but for a long-term holder, you dont need to sell out of your stocks.

There will be impacts (from the debt crisis), but I dont think they will be as monumental as people make out. If you head for the exits you run the risk of an agreement and you miss the pop."

Macey says consumer staples may be the best play if there's a ratings downgrade. "Will people still drink Coke?  Yes.

Macey adds, This is not a question of an inability to pay, its an unwillingness to pay.  The U.S. is going to pay its debts and life will carry on.

Not everyone is so sanguine. Rochdale Securities analyst Dick Bove issued a very bearish note advising suspending investing since all stocks are likely to fall" due to the debt crisis.

And beyond the current crisis, some strategists see bigger problems on the horizon for investors.

The current U.S. federal budget mess is obviously another downer for the economy, notes Michael Belkin, who advises mutual and hedge fund managers with his weekly Belkin Report.

Belkin correctly called market turns at the 2007 top and he was an early bull in 2009.  Now he warns, The economy and markets are headed into a long-term contraction, the last time the forecast looked like this was just before the 2008 downturn."

He advises clients sell into rallies, short technology shares and go long consumer staples.  Belkin also says buy gold and gold mining shares.

Unlike some of their rival firms,  Morgan Stanley (NYSE:MS) market strategists are not looking for a debt downgrade.  But they are concerned about the fallout from any Congressional debt ceiling agreement on the economy. "The real risk to the debt debate is the damage to a fragile economy," they wrote in a cautionary note to clients that speaks to both political parties, bulls and bears alike.

"There's little margin for error for the recovery, the adverse consequences of bad policy and uncertainty are amplified," they said.

Today's weak GDP report illustrates how narrow that margin may be, with the downside risk rising for both economic growth and assets such as stocks while the debt mounts and debate dithers on.