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Before we get to the outlook for stocks in June, let's consider the road May took to bring us here. This year, the "sell in May, and go away" rule was good advice -- assuming you sold at the beginning of the month. Despite achieving a three-year high in May, stocks put up four consecutive losing weeks, which we've not seen since February 2010. Furthermore, it was only on the last day of the month that stocks managed to register a 1% gain, narrowly averting the comparison with May 2007, when the index was at 1,531.
Expect higher volatility
As we begin June, the VIX index remains near the 52-week low achieved in April. Wall Street's "fear gauge," which measures the prices investors are willing to pay for protection for their portfolios, closed at 15.45 yesterday (substantially below its historical average.) This indicates that investors expect low volatility in June, and after all, the summer has begun. As bankers and traders retire to the Hamptons, one would normally expect lower activity and less volatility.
That's the rub -- things are anything but normal this summer. In fact, between the latest manifestation of the European sovereign debt crisis and justified concerns about the slowdown in the U.S. economic recovery, things look very reminiscent of last year. Back then, a correction that had already begun in May continued through June. I'm not predicting a correction -- although we are due -- but I think investors should be prepared for higher volatility than we have experienced recently. There is certainly no shortage of potentially disruptive events.
Waving farewell to QE2
For one thing, June is the final month of the Federal Reserve's second round of quantitative easing, which had the central bank buying government bonds in massive quantities to lower interest rates and inject funds into the banking system. Absent this buyer, it's a bit of a mystery where benchmark government bond yields will end up.
Greece: The sequel
Across the Atlantic, Greece is due to receive the fifth tranche of the original $110 billion European Union/International Monetary Fund bailout this month. However, the IMF has said that it will withhold its payment unless it receives assurances from the European Union that it will cover Greece's funding needs in 2012 (the original plan, going back to the market, went out of the window). Did I mention the growing rift between the European Union and the European Central Bank regarding the restructuring of Greek debt? The former is beginning to consider this option, while the latter is staunchly opposed to any restructuring.
Given the different interests at stake and the cacophony of voices pitching in on the matter, there is more than enough tinder for surprises and wide swings in market sentiment, particularly with Eurocrats on the job -- they never miss an opportunity to mismanage the market's expectations. If you think U.S. stocks are insulated from the fallout of this European carnival, I refer you back to 2010.
Increased market volatility contributes to the second trend I'm looking for in June:
Defensives over cyclicals
The rotation from cyclical stocks into defensive names began in April, continued in May, and I expect it to continue in this month. As more confirming data come in, the market will take the full measure of the economic slowdown. Once investors realize the economy isn't following the script of a normal recovery, they will continue to reallocate away from cyclical sectors into "safe haven" sectors that offer less exposure to the economic cycle: consumer staples, health care, telecoms, and utilities. Meanwhile, expect financials, industrials, consumer discretionary, and financials to bring up the rear.
Energy and technology
What about energy and information technology, you ask? Energy is a tough one to categorize because the companies are so dependent on commodity prices. In this environment, who knows what those prices will do in any given month? Technology companies are dependent on the business cycle, but some of the largest weightings in the sector belong to stocks that already look very cheap. The following table shows the 10 largest technology stocks in the S&P 500, along with the stocks' forward price-to-earnings multiple and the same multiple once you subtract the company's net cash per share out of the stock price:
P/E (on next 12 months' earnings)
P/E (adjusted for net cash position)
|Cisco Systems (Nasdaq: CSCO )||10.0||7.3|
|Intel (Nasdaq: INTC )||9.7||9.1|
|Apple (Nasdaq: AAPL )||12.9||12.1|
|Oracle (Nasdaq: ORCL )||14.6||13.9|
|Qualcomm (Nasdaq: QCOM )||18.3||16.5|
|EMC (NYSE: EMC )||18.4||17.8|
|International Business Machines||12.5||N/A|
|Hewlett-Packard (NYSE: HPQ )||7.4||N/A|
Source: Capital IQ, a division of Standard & Poor's.
Microsoft shares changing hands at less than eight times earnings? Is the Ballmer discount really that large? My sense is that many of the stocks in the table are already close to a floor set by value-oriented investors, who will step in to buy shares when valuations become irresistible. For example, David Einhorn of Greenlight Capital -- a high-profile value investor -- touted Microsoft at last week's Ira Sohn conference. Cynics will say it's simply a case of putting his mouth where his money is; Greenlight already owns 9.1 million shares of Microsoft.