Recent news headlines have been swamped with the political wrangling on the US debt crisis, with some commentators suggesting that a default is a possibility, should the debt ceiling fail to be raised by 2 August. We certainly do not expect a default (in any form) by the US government on its debt, and the US Treasury market seems to agree, with yields remaining relatively stable and recent Treasury auctions still seeing healthy bid-to-cover ratios.

Nevertheless, credit rating agencies have indicated that the US sovereign debt rating may be cut, the implications of which we discussed earlier in April (seeS& P Lowers US Debt Outlook – Implications For Investors), and Standard & Poors has recently hinted that the probability of a downgrade for US sovereign debt may be as high as 50%. We continue to expect that a US debt rating downgrade will not have any adverse impact on global economic growth, nor will it impact the near-term function of the US dollar as the world’s reserve currency. A downgrade of the US sovereign debt rating may also be seen as a temporary phenomenon, and the rating could be raised again following a positive conclusion to the ongoing political gridlock.

How then should investors be positioned in the current environment? We maintain that investors should not lose sight of their long-term investment goals over recent sensationalised stories about US debt default risks, and should continue to invest on the assumption that default is not a credible option for the US government. In light of the current uncertainty, we highlight three investment ideas below:

1. ACCUMULATE EQUITIES ON THE CHEAP

• While debt concerns in the Euro-zone have eased somewhat, the US debt ceiling debate continues to weigh on investor sentiment
• While the current situation has to do with the debt load of the US government, the private sector is in a far healthier position, with cleaner balance sheets, rising cash piles and rising profitability
• Unless a default occurs (which will have more devastating implications for the global economy), we see little threat to corporate profitability major US corporations continue to generate positive earnings surprises (over 70% of S& P 500 companies which have reported 2Q 11 earnings have beaten expectations)

2. SHUN DEVELOPED SOVEREIGN DEBT FOR SGD-HEDGED SHORT DURATION BONDS

• Should US sovereign debt be perceived as more risky, Treasury yields should rise, which contributes to interest rate risk in fixed income
• We continue to favour equities over fixed income, but should investors require lower-risk investments, short duration bonds like the  United SGD Fund  orDBS Enhanced Income SGD  are less interest rate sensitive and are expected to fare better that longer duration global bond funds should interest rates rise
• The USD is likely to be volatile should a potential downgrade ensue, and we continue to maintain a preference for  SGD-hedged or SGD-focused bond funds  to reduce currency volatility

3. PREPARE A “SHOPPING LIST” OF RISKY ASSETS TO BUY

• While we continue to anticipate minimal economic repercussions from a potential debt rating downgrade, there is always the risk that investors may overreact should a downgrade occur
• Risk assets will likely be the worst-hit if investors panic, and one may wish to formulate a list of riskier investments which may go on sale should risk aversion spike significantly
• We anticipate that Emerging Market Equities (Aberdeen Global Emerging Markets,  First State GEM Leaders,  Schroder Global Em Mkt Opps Fund SGD) and High Yield Bonds (PRU Mthly Income Plan Cl A,  Fidelity Asian HY AMDIST SGD-Hged) could provide good investment opportunities should there be panic following a downgrade announcement
• Should gold prices spike on investor risk aversion, investors holding gold-related funds should also see the event as an opportunity to switch out into favourably-valued equity markets

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