Cracking the Code: Why is the Stock Market Thriving Amidst Debt-Ceiling Uncertainty?

Well, it's quite an unexpected scene right now in the U.S. stock market. Things are pretty mellow, even with the looming debt-ceiling crisis. And would you believe it, we've only got a handful of days left before the U.S. breezes past its debt-ceiling due date. This past Saturday, President Biden and Republican House Speaker Kevin McCarthy managed to sketch out a rough agreement to sidestep a potential financial mess. But, hey, there's no guarantee that this plan will sail through the House or Senate, and even if it doesn't get outright tossed, some procedural speed bumps could push back the final legislation.

As it stands, President Biden and House Speaker Kevin McCarthy seem to be steering towards acquiring sufficient support from both sides of the aisle to put a hold on the debt limit. However, even with this progress, they could encounter legislative hurdles that might muddle the rush to avert a first-of-its-kind default.

The bill is up for its initial challenge this Tuesday when it faces the House Rules Committee. This committee serves as the gatekeeper, controlling what legislation gets a chance to be debated on the House floor.

What's wild though is that despite this political circus, the stock market's been bouncing back like it's no big deal. Last week, the S&P 500 even closed out a tad higher, up by 0.3%. Over the last few months, stocks have pretty much shrugged off any headaches caused by banking system stress, stubborn inflation, and interest rate jumps. Remember how last year those issues sent stocks spiraling? Well, this year, the market's reacting with a "been there, done that" kind of attitude.

The market's steady climb has left a bunch of analysts and portfolio managers scratching their heads, particularly since the S&P 500 (purple line) has been on a winning streak, up more than 10% this year. And it's not just them. The tech-heavy Nasdaq Composite (orange line) is enjoying a sweet ride too, with a solid 25% rise year to date (chart below).

So, how can it be that last year, the stock market struggled in the face of very real risk factors, and this year it seems to be thriving? One simple explanation is that it really isn't. There are seven companies, the largest companies in fact, that are carrying the entire market on their collective backs. The chart below from Goldman Sachs' research team shows us that as of May 22nd, Meta, Amazon, Apple, Tesla, Google, and Nvidia (dark line going up) are responsible for nearly 90% of the S&P 500's return this year.

How much value have the remaining 493 companies returned to shareholders this year? Well, if you made a cap-weighted index out of them, your return would be about 1% (light blue line at the bottom). With the three-month treasury rate yielding just over 5% and inflation at about the same, it’s safe to say that the remaining 493 largest companies in the US are not “doing so great,” relatively speaking. Of course, past performance is not indicative of future results!

Another way of looking at this information is by comparing it to the famous Morningstar Market Barometer. This chart presents a visual depiction of returns in the stock market, categorizing them based on their style - such as value, core, or growth - and their market capitalization, which could be large, mid, or small. What we see over the past year is that every category, not just the large caps that occupy the S&P 500, is red. However, over the same period of one year, the S&P 500 total return is a positive 3%. Few are talking about this, but to me, it’s the most important discussion to be had about the current market environment.

What Does it Mean to Me?

A significant part of investing for the long run involves managing expectations. When markets shift away from what is assumed and expected, investors become anxious and start wondering if they need to make changes to their strategy and, in turn, do the worst thing they can do: interrupt the compounding process. 

One of my favorite quotes from Charlie Munger is, “The first rule of compounding: Never interrupt it unnecessarily.” 

Staying up to date with market conditions as they sway further away from what is expected is a great way to heed Mr. Munger’s sage advice. Where do we go from here? That is simple. For us to feel more confident in the market's health, we will want to see more participation in positive returns than from just seven companies. Until that happens, we will continue to enjoy the benefits of properly calibrated time horizons and a diversified portfolio that matches the needs of individual financial plans.