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Summer Doldrums: Will They Last?

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Thursday, June 18, 2015
Money and Markets
Summer Doldrums: Will They Last Into the Summer?
by Mike Burnick

Dear ,

Mike Burnick

Sunday is the first "official" day of summer, although here in South Florida, the weather has been steamy for several weeks already. The dog days of summer lie ahead and with them the usual summer doldrums for stock markets.

Typically the summer months find fund managers away on holiday, trading volume can get thin and markets turn volatile. This summer there are plenty of cross currents already in place, including the ongoing Greek debt drama, the timing of the Federal Reserve's first interest-rate increase in over eight years, and spreading conflict in the Middle East.

So this summer could be anything but dull with investors in for a long, hot summer.

If so, it would be a change of pace from the dull trading-range that has been frustrating investors all year. In fact, the S&P 500 Index (SPX) is currently locked in the tightest weekly trading range in 21 years.

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* For seven straight weeks, the blue chip index has moved less that 1% either up or down. That's the longest stretch of tranquility for stocks since May 1994.

* In fact, the SPX hasn't moved 1% in either direction in 15 of the past 16 trading days.

* And the gap between the highest and lowest close this year is less than 7%, the narrowest range since 2006.

The doldrums are already here. Chalk it up to uncertainty.

Investors have grown somewhat skittish with stock market valuations already stretched and mixed messages about the health of the economy. The unknown timing of the Fed's first rate hike since 2006 just adds to the anxiety.

Since a picture is worth 1,000 words, here's another one on the wall-of-worry for investors:

Click image for larger view

The above graphic, courtesy of Doug Short and Advisor Perspectives, reminds us just how long it has been since we've seen a significant stock market correction or even a minor pullback.

Generally, a market correction is defined as a decline of 10% or more. That hasn't happened to the S&P 500 Index since 2011, although the index came close in the summer of 2012 (-9.9%).

We've had plenty of pullbacks of -5% to -7% or so, although they didn't seem minor at the time, but it has been over 150 trading days since the S&P last declined 5% or more, and more than 900 days have passed since the last 10% correction.

Markets don't usually move higher for this long without a correction of some kind and the longer the upside move continues, the more complacent investors will become, ushering in the next correction when we least expect it.

A pullback is inevitable at some point — why not this summer? Could fears of higher interest rates be the trigger?

Everyone is focused on the timing of the Fed's move, but markets have reacted already. Interest rates have been moving higher, with the yield on the 10-year Treasury rising close to 2.4% today, up from just 1.8% this spring.

Bond markets are already pricing-in Fed rate hikes, but what about stocks?

If history is any guide, investors may have LESS to fear from higher rates than they think. It all depends on the pace of Fed funds rate increases. Higher interest rates haven't always tripped up stocks, according to Bloomberg. Based on a study of rate-tightening cycles since 1946 by Ned Davis Research, the S&P 500 gained an average of 2.9% in the 12 months after the first interest rate hike by the Fed.

And stocks performed even better, with gains of 11%, when interest rates rose slowly over time.

According to the Fed funds futures market, investors have priced in only one interest rate hike of 25 basis points (one-quarter of one percent) by the end of 2015, and a Fed funds rate of just over 1% by the end 2016!

Bottom line: Stocks are certainly overdue for a meaningful correction, and the Fed makes a convenient villain. But officials have been preparing markets for the next interest rate tightening cycle in advance, and are on record saying that the pace of tightening will be slow and measured. And if futures markets are correct, the snail's-pace of expected interest rate hikes is unlikely to derail the stock market.

Good investing,

Mike Burnick

The investment strategy and opinions expressed in this article are those of the author's and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.

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