Citi's guide to trading the debt ceiling: Beware of companies with high revenues from U.S. government

Published Mon, May 8 20232:12 PM EDTUpdated Mon, May 8 20234:45 PM EDT

Investors looking to trade the showdown over the U.S. debt ceiling should focus on stocks that are tied most to government spending, according to Citigroup. Lawmakers have been trying to find a way to raise the debt ceiling so the government can pay its bills on time. On Sunday, Treasury Secretary Janet Yellen warned failing to raise the debt ceiling will cause a " steep economic downturn ." She also repeated the government may run out of money to pay its debts as soon as June 1 . As the fight over the debt ceiling — and talks of spending cuts — ramp up, some stocks will trade down, Citi pointed out. "We do not believe U.S. equities are pricing in enough event risk around a debt ceiling standoff even though U.S. credit default swap markets have moved significantly year-to-date," U.S. equity strategist Scott Chronert wrote in a note Friday. That could present an opportunity to buy put options on the stocks Citi says are vulnerable, giving the holder the right to sell the underlying stock shares at a predetermined price before the contract expires. To find those stocks, the Wall Street firm first looked for companies that have meaningful direct or indirect revenue exposure to the U.S. government. The direct revenue-exposure companies had at least $500 million in market cap and at least $250 million in U.S. government revenue, representing more than 5% of the companies' top lines. Its indirect exposure stock names also had at least a $500-million-market cap. In aggregate, they had more than 5% of revenue tied to those stocks with the most direct exposure. "While relative performance of these exposures could be a good event hedge, we argue that the relative volatility setup of the underlying stocks and related ETFs may prove most effective and durable," Chronert wrote. "Our bias is to consider classic hedges that can be quickly reupped or unwound rather than a two pronged 'sell the concern, buy the Resolution,'" he added. Chronert then added a volatility screen to his list of direct- and indirect-exposure stocks. He looked at the current options pricing setup and found 19 names with at least 10,000 open contracts where 30-day and 90-day at-the-money implied volatility is below that of the SPDR S & P 500 ETF Trust . Here are 10 of those stocks. The list is dominated by the aerospace and defense sector, and includes companies such as Boeing , Raytheon Technologies and Northrop Grumman , all of which are prime contractors for the Pentagon. Boeing, which has implied 30- and 90-day volatility just above 20%, produces aircraft for the military in contracts worth billions of dollars. Arlington, Virginia-based Boeing recently posted a revenue beat , although its adjusted loss per share came in higher than expected at $1.27 versus an estimate of $1.07, according to Refinitiv. Boeing also said in its commercial unit, it plans to boost production of 737 Max planes to 38 per month. Shares are up about 4% year to date. General Electric also receives a good deal of government spending. In its 2022 annual report , released in February, GE touted the nation's growing defense budget and its XA100 fighter engine for the F-35 fighter jet. GE posted a revenue and earnings beat when it reported first-quarter results in late April. The stock is up about 54% so far this year. Due to the heavy weighting of the aerospace and defense sector, Chronert also looked at the sector's U.S.-listed exchange-traded funds. Chronert believes the iShares U.S. Aerospace & Defense , SPDR S & P Aerospace & Defense and Invesco Aerospace & Defense ETFs "could be useful off-the-shelf trading tools to consider." — CNBC's Michael Bloom contributed reporting.