- The U.S. debt ceiling raised concerns as the deadline approached, with potential consequences including missed payments, job losses, and a stock market selloff. Bond yields for shorter-term Treasury bills rose meaningfully to reflect this risk.
- On June 3, President Biden signed into law the bill passed by the House and Senate, suspending the debt ceiling until January 2025.
- Nvidia's blowout earnings and focus on artificial intelligence (AI) drove a significant rally in AI-related stocks, pushing the company's market cap over $1 trillion.
- Despite the S&P 500's modest gain during the month of May, the performance of individual stocks within the index was weaker, highlighting the dominance of mega-cap stocks and the divergence between the NASDAQ and Dow Jones.
The Debt Ceiling
The debt ceiling is the amount of money the US Department of the Treasury is authorized to borrow to pay the nation’s bills. These bills include Social Security, Medicare, and interest on outstanding national debt. Congress regularly raises the US Debt Ceiling so the U.S. can borrow more, but occasionally this process becomes political, igniting a contentious narrative.
Just a few weeks into May there was quite a lot of disagreement and bantering back and forth between the Biden administration and House Republicans over how and whether to raise the U.S. debt ceiling. After reviewing the tax receipts that rolled in from the April Tax deadline, Treasury Secretary Janet Yellen revealed an “X-Date”, or a technical default date, as soon as June 1st. With a week before the deadline, angst and worry filled headlines across the globe.
These emotions were certainly justified because the consequences of the U.S. not raising the debt ceiling in time would not only be unprecedented, but they could also result in a failure for our nation to pay its bills or delay interest payments. Such outcomes could lead to missed paychecks for Federal employees, job losses, delayed Social Security payments, a spike in borrowing costs, and a selloff in the stock market.
In the event of a default, investors were demanding a higher yield on 1-month Treasury bills as compensation for taking on additional risk. The yield for the 1-month Treasury bill got as a high as 6.0% on May 26th, which was 68 basis points greater than the 3-month Treasury bill. This is one of the widest spreads witnessed between the two maturities since the early 2000s.
Data from 12/30/2022 to 05/30/2023.
With the deadline looming, both the House and the Biden Administration were keenly aware of the imperative at hand. Thus, on May 31st, a crucial milestone was achieved as the House successfully passed debt-limit legislation, a testament to the collaborative efforts of both political parties. As the proposal advanced through the Senate, where it was approved on June 1, it was finally signed in law by President Biden on June 3. This approval ultimately kicks the can down the road by suspending the debt ceiling until January 1, 2025.
Stepping beyond the debt ceiling drama, the month of May was packed with scorching moves in AI driven stocks and investments. The big story, of course, was the blowout earnings from Nvidia that ignited a rally for anything and everything that touched artificial intelligence.
For those unaware of what Nvidia is all about, it produces and distributes graphical processing units (GPU) that are utilized in a variety of end markets with specializations in gaming, professional visualization, data centers, automotive, and Large Language Models (LLMs). In addition to their hardware, NVDA also creates software used in machine learning, artificial intelligence, cloud computing, and virtual/augmented reality. AI was a big focus this quarter, with the term being mentioned 91 times on the company’s conference call, and after the company raised its next quarter sales forecast from $7.2 billion to $11 billion, the stock exploded higher by more than 24%, propelling the company into the $1 trillion dollar market cap club.
Just to put that market cap move into perspective (approximately $250 billion), it was larger than size of 95% of the stocks included in the S&P 500 Index.
AI has been among us for years. The release of ChatGPT is just a recent example, but if you’ve ever interacted with Alexa or Siri or even received an unsolicited grammar revision on your phone—congrats—you’re an AI user. Ultimately, the output of AI is just a tool that processes and organizes data to identify patters and summarize information or make suggestions.
The big question now is: Will firms use AI to beat the market?
Wes Crill, PhD, and Senior Investment Director at Dimensional Fund Advisor, doesn't seem to think so. He writes in his latest blog post, titled "From Skynet to ChatGPT: AI and Its Investment Implications,” "Material information gleaned from running AI processes is very likely a subset of the vast information set known by the market in aggregate and reflected in market prices. If new information is obtained, the process of acting on that information (buying or selling stocks/bonds) incorporates it into market prices. As more investors employ these tools, any edge from doing so should wane.”
In short, while AI may produce a temporary edge for investors that use it to better gauge market expectations and eye market anomalies, the wisdom of the crowd may ultimately trump this edge due to the stock and bond markets acting as complex adaptive systems.
The Good, the Bad, and the Ugly
While the Fed may be on hold this month when it comes to raising interest rates (only a 24% probability of a 25 bps hike)1, it is by no means the ultimate end to the policy cycle. There were several restatements of previous data last week, particularly the increased initial jobless claims. However, the increase in these claims was deemed fraudulent in Massachusetts, and without those false claims, there has been no major increase in jobless claims.
The job market appears to be humming along. Nonfarm payrolls grew 339,000 in May, following an upwardly revised 294,000 increase in April, according to the Bureau of Labor Statistics. On the other hand, the unemployment rate increased to 3.7% from 3.4%, whereas average hourly earnings increased by 0.3% month-over-month. Despite the reality that labor demand has remained resilient, it is unclear how long this will endure with the credit crunch threatening to derail the expansion.
At face value, May was not a bad month for equities. The S&P 500 managed to gain 0.25%, but under the hood, that move was less impressive. The average stock in the index actually fell 4% during the month. In other words, mega caps were pulling more than their fair share of weight. Year-to-date hasn’t been much of a different story, with the median stock in the S&P 500 Index down -1.4% and the average stock in the index only up a measly 0.8%.2
Small cap companies, as represented by the Russell 2000 Index, are down -0.04% year-to-date, the Dow Jones is down -0.13% for the year, and the NASDAQ Composite Index is up a monstrous +24.06%. Comparing the performance difference between the ‘great’ (NASDAQ) and the ‘ugly’ (Dow Jones) in May, the Nasdaq outperformed the Dow by 9.29 percentage points, which ranks as the 9th widest margin of outperformance for the Nasdaq relative to the Dow in history. 3
Data from 12/30/2022 to 05/31/2023.
The moral of the story is this: if you haven't been fortunate enough to board the AI narrative freight train this year or tilted towards mega cap stocks, you may be looking at your equity portfolio and wondering where the rally is.
(2) Bloomberg. “Stocks Have Never Looked So Bad With the SPX So Good: Macro Man”. Cameron Crise.
(3) Bespoke Investment Group.