Special Report from Money Morning

by Garrett Baldwin, Money Morning

Some call it a “perfect storm” and others a “financial apocalypse,” but it doesn’t matter what you call the fiscal headwinds facing the U.S. economy – just that you watch them, and the stock market “crash talk” they’re stirring up.

With talk of the Hindenburg Omen, credit crunches, and struggling emerging markets, it’s important to prepare for the potential impact of bumps ahead.

Despite a strong rise for the stock market so far in 2013, many of the structural and political concerns highlighted during periods of political convenience in Washington have not gone away. Every year it seems that Congress kicks the can down the road, only to act shocked when the economy stalls and the can is back at their feet.

Bottom line: This fall could turn out to be a volatile time for U.S. investors. As investors, if we can’t change Washington today, we can prepare now for any stock market crash, correction, or volatility that these headwinds bring.

Here are the biggest four headwinds to keep your eyes on:

Stock Market Crash Triggers

1. The Quantitative Easing (QE) Taper Talk Heats Up

   Two months ago, U.S. Federal Reserve Chairman Ben Bernanke floated a plan to taper the $85 billion monthly bond program that has fueled a surge in the global economy. Now any hints from the Fed that a taper is near sends the market tumbling into triple-digit declines.

   Without Bernanke’s QE program to flood the markets with cheap money, there will be more market jitters – particularly in retail stocks. In fact, retailers are so desperate given the lackluster sales for the year already that some have already started holiday sales this month.

   There has also been a strong pullback from investors in emerging markets.

   The pullback has reduced investor risk for higher yields and led to a dramatic downturn in countries like Thailand, Indonesia, India, and Malaysia and a rise in volatility. But it’s also sending ripples into Europe, particularly as U.S. interest rates are on the rise.

2. Government Shutdowns and Debt Ceilings

   Now that Congress has returned from August recess, it has to deal with two important elements: a budget to finance government and a looming debt ceiling deal that is expected to be just as political as ever.

   Don’t expect a simple agreement or continuing resolution to finance spending as an easy agreement.

   Republicans are expected to demand tax reform and changes to Social Security and Medicare in return for hikes to government borrowing levels. Unfortunately, as the government blows past the $17 trillion threshold, it’s clear that neither Republicans nor Democrats are prepared for the potential blowback that capping the borrowing limits could lead to.

   We’ve been down this path before. In the event of a government shutdown, essential services would likely not continue, and government would default on certain debt payments. Though unlikely, as the Oct. 1st budget deadline approaches and talk in Washington heats up, ripples through the global economy could soon materialize.

   Any defaults or another downgrade to U.S. bonds could spark significantly higher borrowing costs, a consequence that could have grave impacts on how companies are able to finance expansion and grow. In addition, it would affect Americans in every facet of their lives, from college to mortgage loans.

   As for a stock market crash, the last debt ceiling battle in the summer of 2011 triggered a 15% drop in the S&P 500 from July to September.

3. Interest Rates Are on the Verge of Panic

   The threat of a government shutdown and corresponding government default has fueled concerns about higher borrowing costs. But with the Fed’s cheap money policies, the markets have witnessed sharp rises in bond yields.

   The biggest concern right now in the financial markets centers heavily on interest rates, as credit default swaps. Like the housing market, investors placed an immense amount of money into derivatives anticipating that housing prices would continue to rise and borrowers would meet their mortgage payments. We all know how that happened.

   But in today’s market, investors flooded interest-rate swaps with the expectation that rates would remain flat and that Bernanke would hold the line on borrowing costs. Sharp changes in bond yields could unleash a chain reaction across the swap markets, and once again, the “can’t miss” investment tool could become the weapon of financial destruction we’ve all known it to be all along.

4. September and October

   Historically, the 60 days of trading after Labor Day weekend haven’t provided the best returns for investors. Average September returns for the S&P 500 from 1929 to 2012 were a 1.1% decline.

   Stock market crashes of 1929, 1987, and 2008 all occurred in October, which is coincidental, but another harbinger that lurks on the horizon. Traditionally, investors breathe a little easier when the first of November rolls around, although this coming October could feel a bit longer than usual with a full 23 days of trading, the most possible for the month.

Now here’s how to prepare your portfolio for the chance of a stock market crash…

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About the Author

Garrett serves as Executive Editor at Investment U and works extensively with Publisher Jay Livingston on building the news cycle and content.

A former Wall Street and energy consultant, Garrett has worked in various leadership roles in financial publishing, competitive and market intelligence, corporate advocacy and financial planning. During his career as a professional and academic writer, he has written extensively about the financial crisis, corporate governance, executive leadership and the energy markets.