Markets This Week, 5/15-19 2023: Tech a Safe Haven from Debt Ceiling Impasse and Bank Troubles

The markets are closely watching the ongoing negotiations on the debt ceiling, which have been paused after Republican negotiators left the meeting calling the White House representatives “unreasonable.” If the U.S. fails to raise the debt limit and delays government payments, it might lead to a stock market plunge of up to 20% and hurt the economy. Meanwhile, more forced bank mergers may be needed in the near future, according to Treasury Secretary Janet Yellen, putting the KBW Nasdaq Regional Banking Index under pressure. The question of a pause or no pause in rate hikes in June remains on the table, while technology stocks continue to be the safe haven for investors.

Debt Ceiling and Bank Troubles

The debt ceiling has been dominating the markets’ attention, with ongoing negotiations in progress. Republican negotiators calling the White House representatives “unreasonable” and putting the talks on pause has increased worries in the markets, with the S&P 500 (SPX) touching its 9-month high before the breakdown. Analysts warn that a failure to raise the debt limit and delays in government payments might lead to a stock market plunge of up to 20% and hurt the economy. Additionally, the report of more forced bank mergers needed in the near future has put pressure on the KBW Nasdaq Regional Banking Index.

The Question of a Rate Hike Pause

The question of pausing or not pausing the rate hike in June remains on the table and is closely watched by investors. Federal Reserve Chair Jerome Powell indicated that he wants to wait and see whether the effects of previous hikes, coupled with credit tightening stemming from the banking sector’s troubles, are decelerating inflation. Other interest rate committee members, however, are not convinced that the price pressures are coming down quickly enough to warrant a pause. While the chances of a pause in June are high, barring any unexpected events, it is not yet a done deal.

Tech Stocks Remain a Safe Haven

Technology stocks have been the safe haven for investors during the turmoil of the past few months. With a weakening economy, inflation, and the corporate sector in an earnings recession, the tech sector is one of the few that offers prospects of earnings growth. Large technology companies are insulated from the banking turmoil as they are not dependent on bank funding and benefit from the latest market craze, the generative AI technology. Prudent investors have limited options in the U.S. markets, and thus, they have been increasing their exposure to equities, particularly technology stocks. Hedge funds have been following the same path, reducing their exposure to cyclicals, including financials and commodities, and increasing their exposure to defensives, mostly technology stocks.

Related Facts

• UBS strategists have warned that if the U.S. fails to raise the debt limit and delays government payments, stocks might plunge as much as 20% and the economy will take a hit.
• Treasury Secretary Janet Yellen reportedly said that more forced bank mergers will be needed in the near future as the industry is still in crisis.
• A survey by Bank of America conducted May 5-11 shows that global fund managers are preparing for a soft landing with a small earnings contraction, while they have increased their exposure to equities, mainly technology stocks.
• Hedge funds have reduced their cyclical versus defensive exposures to the lowest level since Q3 2020.

Key Takeaway

The ongoing negotiations on the debt ceiling and the question of pausing or not pausing the rate hike in June continue to be closely watched by investors. However, technology stocks remain the safe haven for prudent investors, as large technology companies are insulated from the banking turmoil and offer prospects of earnings growth even in a weakening economy. While the tech sector will continue benefiting from digital transformation in the long term, in the near term, it may be in overbought territory with excessive valuations, increasing the risk of a correction.

Conclusion

Although markets rose through the week on optimism about the ongoing negotiations on the debt ceiling, the sharp reversal on Friday following the Republicans’ decision to pause the talks indicates the ongoing uncertainty in the markets. Investors are closely watching the developments and are increasingly repositioning out of cyclicals and into defensives, mostly technology stocks. Prudent investors who have already invested in Big Tech may continue to hold their positions. However, those contemplating their entrance in the tech sector should be cautious as the sector may be in overbought territory with excessive valuations, increasing the risk of a correction in the near term.