Debt Ceiling Resolved, Strong Jobs Report, Tech Dominating
What's happened recently?
The debt ceiling standoff dominated headlines in May and created volatility in markets, especially for short-term bonds. The U.S. consumer continues to be the backbone of the economy and recent data shows its continued resilience. Outside of the consumer, however, data is more lackluster.
Here are a few things standing out in the news:
Uncertainty around the debt ceiling as well as knock-on effects from recent bank failures have created a more volatile backdrop for equities since the beginning of May. During May, the eight largest tech companies in the S&P 500 (nearly 27% of the index) more than offset weak performance elsewhere in the markets, boosting the large cap growth category’s dominance of markets (see exhibit below, left). These stocks might have benefited from association with AI as well as being more insulated from banking and debt ceiling effects. Since the beginning of June, market performance has shifted, benefiting smaller, more value-oriented stocks (see exhibit below, right). However, it is still too soon to tell if this is a catch-up trade or a more sustained shift in fundamentals.
Why is this important?
Markets have moved beyond focusing on the debt ceiling and the highly uncertain but disastrous consequences. Investors are back to scrutinizing economic fundamentals, which are holding up better than expected. Equities and bonds have seen this shift in focus in their performance since averting a default.
- The debt ceiling has been suspended until January 2025, avoiding an unprecedented government default. While the delay means this issue will resurface in a couple of years, the worst of the immediate market risk tied to the standoff should be behind us.
- Strong labor markets are a source of strength for the U.S. economy, but it is also a focus of the Fed as it tries to bring down inflation. Given this strength, the Fed isn’t expected to ease up on tightening monetary conditions before year end and has mostly unwound the temporary stimulus it provided during the recent banking turmoil.
What's our take?
We are glad the debt ceiling overhang has been resolved and markets can start focusing more on the fundamentals, for the economy and individual companies.
- A healthy consumer should keep the economy on an even keel, but we are still facing a much tighter lending environment which affects the economy with a lag.
- As markets move higher, we are keeping an eye on expectations outpacing fundamentals, which still point to a fragile economy and the possibility of greater volatility going forward.