Trader Leon Montana works on the floor of the New York Stock Exchange stocks NYSE worry
AP Photo/Richard Drew
JPMorgan warned Monday that stocks could see a dramatic sell-off if lawmakers can’t reach a debt ceiling deal.
As the so-called X-date nears, analysts at the bank sees a potential for a “violent” risk-off move in equities.
Additionally, there’s potential for “Federal spending cuts across key Biden legislative priorities.”
The stock market could see a worse sell-off than it did in 2011 if Congressional leaders and President Joe Biden don’t resolve the debt-ceiling crisis, JPMorgan strategists led by Marko Kolanovic said in a note on Monday.
So far, stock market moves have been relatively muted amid negotiations in Washington, and the Cboe Volatility Index — known as the stock market’s fear gauge — has stayed near post-pandemic lows. But the near-default of 12 years ago should serve as a cautionary tale, the firm said in a Monday note, when the S&P 500 crashed 17% in two weeks.
In that episode, the brinkmanship over the debt ceiling caused S&P Global to slash the US’s triple-A credit rating, downgrading the debt tied to the world’s largest economy to AA+ in August 2011.
The JPMorgan strategists reiterated their base case remains that politicians ultimately reach an agreement that prevents a national default, but even that scenario drives “significantly higher market instability than appreciated by the market currently,” they said.
Still, it’s possible that stocks in 2023 could fare worse than in 2011 due to the contrasting cyclical trends of each period. Today, monetary policy is in a tightening phase versus 2011’s easing, and the money supply now is collapsing rather than expanding. Additionally, valuations were much more attractive in 2011 compared to now.
“A combination of a challenging political backdrop, sooner than expected early June x-date, lack of alternatives if Congress fails to act and sanguine equity positioning suggests an elevated risk of significant equity repricing if the x date is crossed without a debt ceiling resolution,” JPMorgan strategists wrote.
Aside from a “violent risk-off move in equities” that could come as a default nears, the analysts also warned of potential spending cuts across some of Biden’s legislative priorities, such as the Inflation Reduction Act or Chips and Science Act.
“We recommend investors looking to hedge this potential risk to buy VIX call spreads and downside protection on small caps,” the strategists said. “With respect to government spending, we recommend paring down exposure to Green/Climate/EV beneficiaries and highlight Energy permitting reform sensitive companies as potential beneficiaries.”