Investors are jittery about debt-ceiling negotiations. If there’s no resolution by the end of the month, the market will slide, but the classic defensive sectors of utilities and consumer staples will still hold up fairly well.
The latest update on the debt ceiling was positive, though the situation remains unresolved. President Biden signaled confidence in a resolution soon and said that talks with Republicans have been productive. The two sides are in disagreement over fiscal spending parameters relating to how much money the Treasury can borrow.
One of the theoretical concerns regarding the stock market is that a shortfall of baseline government spending could hurt economic activity. That’s why developments on the issue have caused day-to-day swings in the stock market. Higher yields on government debt, should the Treasury’s creditworthiness remain a true concern, would push rates on other bonds higher, putting additional strain on borrowing and spending in the economy.
If the Treasury has no funding by the end of May, it could default on liabilities, and holders of short-term U.S. debt would not be repaid in full. That’s why the price of one-month Treasury debt has dropped, sending its yield higher. That’s stoking concerns about money-market funds that hold the debt, and holding back the
S&P 500,
which has been flat since the end of April.
The defensive sectors could certainly pop if the debt-ceiling picture darkens. Defensive stocks are coming off a huge run last year and they’re not ready to break through resistance, yet. Lately, they’ve been underperforming the S&P 500. The
Utilities Select Sector SPDR
exchange-traded fund (XLU) is down just over 5% since the end of April, while the
Vanguard Consumer Staples
ETF (VDC) is down just over 2%.
But utilities and consumer staples have more runway from here if the debt situation gets ugly. That would spark a defensive trade in the market, and history bears that out.
On average, the S&P 500 utilities sector drops only in the low-single-digit percentage points when debt-ceiling concerns rear their head in episodes dating back to 2011, according to data by RBC. The sector saw positive returns in five out of 10 such instances in that time frame.
Consumer staples see a mid-single-digit decline, the RBC data show. People prioritize household essentials such as toothpaste or paper towels during economic stress.
Meanwhile, the majority of other sectors, which are more economically sensitive and cyclical, tend to see near double-digit declines during debt-ceiling issues, with financials usually dropping almost 10%.
If utilities and defensives get bid up in the coming weeks, investors have two choices: sell them should the debt situation gets resolved, or keep holding them if the debt situation actually becomes a disaster, and cyclicals keep getting crushed. The fixed-income market is ahead of the stock market on the debt issue right now—and it’s even a negative indicator for stocks—but the defensive trade will kick in if things get bad.
Assuming the debt ceiling is resolved either before the end of the month or shortly after a default, the government will pay its bills. That could present a buying opportunity in the economically sensitive sectors, or a chance to sell out of defensive names should they stage a run-up.
To be clear, the U.S. has never defaulted on its debt. But should it happen this time, defensive stocks would have more room to run.
Write to Jacob Sonenshine at [email protected]
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