Market action is muted on Monday morning, but three significant issues will come into play this week and help determine market direction.
Debt Ceiling
The first is the debt ceiling issue. Intense negotiations continue as Goldman Sachs (GS) warns that the Treasury Department will run out of cash as early as June 6. Biden Administration officials warn of very severe economic consequences, including a market collapse, but so far there has not been any notable response from the market. There is a strong belief that a deal will be struck at the last minute despite the harsh rhetoric, but we will see some huge moves if it isn't.
The more likely issue that the market will face is whether there is a 'sell the news' response to a deal. The market has been pricing in a favorable resolution, and there will likely be a celebratory spike on a headline but then what?
Mike Wilson of Morgan Stanley (MS) has been wrongfully bearish all year, but he is warning that a debt ceiling deal may be the catalyst that ends what he calls a 'bear market rally.' The logic is that a deal will cause a contraction in liquidity. Money has been flowing into big-cap technologies names that are viewed as a safe harbor from default by Treasury.
Wilson says this is the inverse situation of what happened with banks, where the bad news created a surge in liquidity due to bailouts, and that prevented the market from trending lower.
Narrowness of the Market
This will bring into focus the second market issue, which is the narrowness of the market. Big-cap techs have been outrunning the rest of the market for several reasons. One is that these stocks are seen as the beneficiaries of the AI revolution. Institutional investors want exposure to this theme and are willing to pay up to get it.
The AI theme combined with the save haven status has been driving this two-tiered market, but how much longer can it continue? Traders were wrong last week about a reversal of the underperformance of small-caps, but the debt ceiling issue may be the trigger for a stronger rotation.
Slowing Inflation and Economic Growth
The third issue the market will grapple with this week is the relationship between slowing inflation and economic growth. There was a spike in the likelihood of a Fed rate hike last week, but that reversed sharply as some doubts about the economy popped up again.
The biggest story of the market this year has been how it is fighting the clear warnings by various Fed members that rate hikes are unlikely to occur until next week. If the Fed changes its mind about that, it will be because of major economic slowing. There are some signs that are occurring, but the market is still very optimistic that a soft landing is coming.
My game plan is to keep hunting for some good technical setups to buy. I am looking for shorter-term trades and am not interested in buying longer-term at this point. There isn't much out there right now.
