US debt ceiling deal could stall safety flight fueling megacap rally
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[May 19, 2023] By
David Randall
NEW YORK (Reuters) - A potential deal to lift the U.S. debt ceiling
could spur money managers to pare holdings in the massive technology and
growth stocks that have been havens this year and shift into the rest of
the market, some investors believe.
Strong balance sheets and predictable cash flows have made megacap
stocks such as Google parent Alphabet, Microsoft Corp and Amazon.com
attractive places to hide over the last few months as investors worried
about everything from the debt ceiling to a U.S. banking mess.
That has boosted their share price and buoyed market indexes, while
leaving other stocks behind.
Megacap tech stocks command heavy weightings in major indexes. Their
rally has been responsible for all of the 8.3% year-to-date gain in the
S&P 500 through Wednesday's close, a Deutsche Bank report showed.
Without them, the index would be down 0.5% for the year otherwise,
according to the research. Through Thursday's close, the index was up
9.3%.
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Should a deal on the debt ceiling be reached, "the pattern that we've
seen over the last few months will reverse," said Michael O'Rourke,
chief market strategist at Jones Trading, who is more bullish on
equal-weighted S&P 500 exchange-traded funds than the market-cap
weighted index. "The market as a whole is pricing in a lot more risk
than those mega-cap names, and going forward a resolution could mean the
market broadens out and outperforms that group."
Investors are watching Washington for signals that the White House will
come to an agreement with congressional Republicans to increase the U.S.
borrowing limit before the so-called X-date of June 1, which the
Treasury Department has said is the day the federal government will run
out of money to pay its bills. President Joe Biden and top U.S.
congressional Republican Kevin McCarthy both expressed confidence
Wednesday that a deal would be reached, avoiding fallout that would be
sure to roil financial markets.
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Spreads on U.S. government one-year credit default swaps - market-based
gauges of the risk of a default – have been declining over the past few
days amid signs of progress on debt ceiling discussions, standing at 154
basis points on Thursday, about 20 basis points below last week’s
levels, according to S&P Global Market Intelligence data.
A recent survey of global fund managers from BofA Global Research showed
that 71% believe a deal to raise the debt ceiling will be reached before
the X-date.
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Traders work on the floor of the New
York Stock Exchange (NYSE) in New York City, U.S., April 10, 2023.
REUTERS/Brendan McDermid/File Photo
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Randy Frederick, Managing Director of Trading and Derivatives at the
Schwab Center for Financial Research, believes a deal would prompt
investors to move back into shorter-term U.S. Treasury maturities,
which some have been avoiding due to debt ceiling concerns. A deal
could also boost shares of companies in sectors that are benefiting
from the continued strength in the U.S. economy, such as consumer
discretionary, Frederick said.
“Giant mega cap companies that have huge balance sheets have been a
nice place to hide," he said. "We expect to see some movement back
into Treasuries because you're getting a nice yield, and some other
parts of the equity market that have lagged behind.”
Of course, investors are unlikely to abandon tech stocks entirely,
after a decade during which the category has led markets higher.
Excitement over artificial intelligence, which has boosted some
megacap names this year, is another factor that could support the
category.
Many would also view a broadening of the equity rally as an
encouraging sign of the market’s overall health.
“For the market to send a stronger signal substantiating direction,
we will need to see ... improved breadth/participation,” John Lynch,
chief investment officer at Comerica Wealth Management wrote earlier
this week.
At the same time, the debt ceiling has been only one of of several
worries weighing on the market. Concerns that the Federal Reserve’s
aggressive monetary policy tightening could reduce economic growth,
and worries about the recent tumult in the banking sector are likely
to remain, even if a default is avoided.
Paul Christopher, head of global market strategy at Wells Fargo
Investment Institute, expects lawmakers will reach an agreement to
extend the debt ceiling through September.
Among the sectors he is bullish on is healthcare, a part of the
market seen as a haven during troubled economic times.
“It’s been a very tilted market,” he said. "We think investors are
going to look through this soon and try to find areas that are going
to generate revenue if growth comes down."
(Reporting by David Randall; Additional reporting by Davide
Barbuscia; Editing by Ira Iosebashvili and David Gregorio)
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