Are FANGs the New Safe Haven?

First, let me say that I have no particular insight into how the process of raising the debt ceiling will turn out. There is the optimistic point of view, which is that it has to get done, it always has gotten done, and therefore it will get done again. This scenario assumes that politicians on both sides will act rationally and proactively to head off the financial repercussions and political peril associated with the failure to act. In relatively short order, the combatants will quit their posturing and, at the very least, kick the can down the road by temporarily extended the debt ceiling. The more pessimistic point of view, which is that the opposing sides are so dug in that it will take a financial crisis to produce a compromise in the nick of time, is also a possibility. Under this scenario, politicians on both sides will conclude that the lion’s share of the blame for the fallout will be borne by the opposing side. As such, each side will make the calculated decision that the political gains outweigh the near-term pain. Either scenario seems plausible, and I would put the odds of either at right around 50/50.    

You may notice that in both optimistic and pessimistic views, the ceiling gets raised before the effective deadline. The only differences are when and the extent of the (largely temporary) damage that occurs prior to that inevitable conclusion. For the most part, the financial markets seem to agree with my analysis. With the exception of a spike in yields on T-bills (the yield on the 1-month Treasury bill has increased from 3.30% on April 21to 5.52% today), it doesn’t appear that the financial markets are signaling any imminent danger. Longer-term Treasury yields remain firmly within a trading range, and the S&P 500 and Nasdaq are up 7.7% and 18.3%, respectively, for the year through yesterday. But are there signs of anxiety if we dig a bit deeper? Perhaps.   

My market commentary from April 28 discussed a trend that could be an indication of some fear out there. Money is pouring back into the mega-cap Technology and Communications Services stocks that have been so instrumental in driving the major market indices higher over the past many years (excluding 2022, of course). In the chart below, you will see that the rush into the mega-caps has accelerated recently while the S&P 500 has been treading water and the equal-weight S&P 500, which assigns a 0.2% weighting to each of the S&P 500 constituents, has actually dropped about 4% over the past month. Are investors reducing risk by treating the mega-caps as a safe-haven while these debt-ceiling negotiations are taking place? It sure seems that way. And it makes sense since these companies, by and large, have great balance sheets with immense vaults full of cash. And if this flight-to-safety is what’s actually happening, could these mega-caps be vulnerable to a correction if/when the debt ceiling does get raised? That also seems plausible, especially following the massive run those names have had this year. And given that these mega-caps have such big weightings in the major indices, a sizeable correction in these names could make the overall indices vulnerable as well. Just something to think about.

What’s an investor to do? My advice is to do nothing. Changing your investment plan based on a very low probability (but admittedly highly impactful) “black swan” event such as a US default is not likely to help you reach your investment goals any sooner. US Treasuries are widely viewed as “risk-free” assets. This means investors believe there is almost no credit risk associated with lending to the US government. In a worst-case scenario, the US government could simply raise taxes or print more money in order to service its debt. Given US Treasuries’ status as a “risk-free” asset, Treasury yields are the starting point in the process of valuing all other financial assets (as well as most non-financial assets). In other words, if US Treasuries are vulnerable, so is everything else. We don’t think anything so dramatic is going to occur. Rather, we believe this crisis will pass and Treasuries will remain the asset on which valuations for all other financial assets are based. Stay the course.