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Investors worry about debt-ceiling negotiations. If there is no resolution at the end of the month, the market will slide, but the classic defensive consumer and consumer staples will still hold up well.

The latest update on the debt ceiling was positive, although the situation is far from resolved. President Biden recently indicated that he has confidence in the decision and said that the discussion with the Republicans was productive. The two sides are at loggerheads over fiscal spending parameters that determine how much money the Treasury can borrow.

One of the theoretical concerns about the stock market is that a lack of government spending can hurt economic activity. That is why the developments in the matter have resulted in daily changes in the stock market. Higher yields on government debt, if the Treasury’s creditworthiness remains a concern, will push up rates on other bonds, putting additional pressure on borrowing and spending in the economy.

If the Treasury doesn’t have any funding at the end of May, it can default on the debt, and short-term U.S. debt holders won’t be paid in full. That’s why one-month Treasury bills fell, pushing yields higher. This has raised concerns about money-market funds holding the debt and hoarding the debt.


S&P 500,

which has been flat since the end of April.

If the debt ceiling picture darkens, defense sectors can certainly emerge. In the past year, defense stocks are coming at a high speed and are not yet ready to break the resistance. More recently, the S&P 500


Select Utilities Sector SPDR

The exchange-traded fund ( XLU ) is down more than 5% since the end of April.


Vanguard is a consumer staple

The ETF ( VDC ) fell more than 2 percent.

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But consumer and consumer staples have more runway than this if the debt situation worsens. This triggers defensive trading in the market, and history shows that.

On average, the S&P 500’s utilities sector declines by only a low-single-digit percentage point, in 2018. Debt ceiling issues have reared their heads in the segments since 2011, according to data released by RBC. In five out of 10 instances during this period, the sector has shown positive returns.

Consumer staples will see a decline in mid-single digits, RBC data shows. People prioritize household essentials like toothpaste or paper towels during times of economic stress.

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Meanwhile, most other sectors, which are more economically sensitive and cyclical, tend to see double-digit declines during debt-ceiling issues, with financials typically falling by around 10%.

If utilities and defenses bid up in the coming weeks, investors have two choices: sell if the debt situation is resolved, or if the debt situation is truly a disaster and cycles continue to break. The fixed income market is ahead of the stock market when it comes to debt – and is a negative indicator for stocks – but if things go wrong, the defensive trade will kick in.

Assuming the debt ceiling is met before the end of the month or shortly after it is suspended, the government will pay the bill. That could create a buying opportunity in economically sensitive sectors, or sell outside of defensive names if they’re preemptive.

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To be clear, the US has never defaulted on its debt. But if it happens this time, defense stocks will have more room to run.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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