Investors Bail on Government Contractors Amid Debt-Ceiling Standoff

(Bloomberg) — Beneath the relative calm in American equity markets amid the standoff over the US debt limit, signs are emerging that investors are moving away from companies with outsize reliance on federal government contracts.

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A basket of mainly defense contractors compiled by researchers at Citigroup Inc. has fallen 3.7% in the past four weeks, over 3 percentage points worse than the S&P 500. The firm screened for companies that derive at least $250 million and 5% of their total annual revenues from federal contracts. It includes Raytheon Technologies Corp. and Northrop Grumman Corp. — which are both down at least 4% since Treasury Secretary Janet Yellen warned on May 1 that the government could run out of money to pay bills as early as June 1.

The basket also holds health care and information technology stocks, including Pfizer Inc. and Accenture Plc, which have slipped as well.

Although there are plenty of other factors weighing on investor sentiment — including recession risk, uncertainty around the Federal Reserve’s next moves and sticky inflation — fears of a potential US default are cropping up in parts of the market. Within options, hedges against a volatility breakout are seeing the most demand in five years. And the cost of credit-default swaps on one-year Treasuries has soared to a record.

Read more: Hedge Fund Manager Wadhwani Says US Default Risk Worse Than 2011

To the team of Citi strategists including Scott Chronert, US equities are not pricing in enough event risk around a debt-ceiling standoff. While prices have fallen, the 30-day implied volatility for the basket of stocks has dropped all year.

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“Investors looking to mitigate event risk could consider some traditional hedges as we expect S&P 500 downside into mid-year,” the strategists wrote.

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