Stocks are down over -5% thus far in June. While a snapback rally cannot be ruled out over the next few weeks with a final $56 billion dose of Fed stimulus still on its way between now and June 30, the breakdown in several fundamental, technical and behavioral indicators suggest that the recent downturn in stocks will likely have much further to go as we move through the summer:
Recent readings on the U.S. economy have been increasingly weak, which does not bode well for stocks in an environment where stimulus is about to disappear. In addition, the situation in Greece continues to deteriorate, with potential fallout effects that could impact both the European and global economy.
Technical Chart Patterns:
During the entire QE2 rally since last August, stocks had been firmly holding various support levels. But since the beginning of June, stocks have been cutting like a hot knife through many of these important support levels including its 50-day, 100-day and 150-day moving averages and its previous low on April 18. While several levels of major support still exist including the 200-day moving average and the March 16 lows, it has been notable how decisively the market has plunged through previously bulletproof support levels over the course of just a few days in June.
1st Day of the Month Effect:
Since the aftermath of the financial crisis, stocks have typically rallied on the first day of the month. For example, stocks have risen by nearly +1% on average on the first day of the month since the Fed launched QE2 last year. This trend is driven by mechanical reasons including the flow of retirement plan money into the market as well as sentiment factors such as portfolio managers positioning for return opportunities to start the new month. On June 1, stocks dropped by -2.28%, signaling investor concern about the outlook.
1st Day of the Week Effect:
Over the same time frame, stocks have also tended to perform well on the first day of the week. Sometimes referred to as Mutual Fund Monday, this effect is driven by capital flows into mutual funds that are put to work in the market on Mondays. Although this indicator has been deteriorating for months, the -1.08% decline on June 6 was one of the worst Monday outings for stocks in a QE supported market. This coupled with the fact that volume was notably low indicates reluctance by mutual fund managers to put fresh cash to work in stocks.
Since the beginning of the QE era in March 2009, stocks have typically rallied when the Fed Chairman makes a major speech. Even if he says nothing of consequence, stock investors have usually found a way of gleaning something positive from his words to rally higher. But when the Fed chairman took the podium on Tuesday, June 7, markets immediately rolled over and dropped by nearly -1% in about an hour. Once again, this price movement had little to do with anything Bernanke said – much of his speech had already been leaked into the market earlier in the day. Instead, this market response was likely a signal to the Chairman of investor concern that without more Fed stimulus (QE3), stocks will lack the fuel to continue to rally higher.
It has been expected for some time that stocks would begin to weaken in anticipation of the end of QE2 on June 30. And portfolio allocations have been adjusted for months in preparation for this eventual turn in stocks.
Many of the asset class categories that are expected to perform well during a Post QE2 stock market correction are off to a good start. Leading among these are U.S. Treasuries, which are up nearly +1% for the month. Selected non-financial preferred stocks have also jumped roughly +1%. In addition, Treasury Inflation Protected Securities (TIPS) are up +0.5% in June, while other categories such as Investment Grade Corporate Bonds and Gold are holding steady near breakeven so far for the month.
Looking ahead to the coming week, the next few trading days will be important in signaling whether one last rally in stocks is coming before QE2 draws to a close on June 30. Otherwise, the pace could begin to pick up to the downside. Stay tuned.
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