Why Investors Should Expect Market Weakness In June


Mutual fund investors earned modest gains in May as the stock market defied the "sell in May and go away" script, rising for a seventh straight month -- the longest winning streak since 2009, when the bull market started.

The average U.S. stock mutual fund added 2.67% in May, lifting year-to-date performance to 14.08%. The S&P was up 2.34% and 15.37% in those periods.

Investors must brace for volatility in June and the rest of summer, analysts said. Aside from it being a seasonally weak period, the market fears the Federal Reserve will taper its quantitative easing programs sooner than expected, and resulting rising interest rates threaten growth.

June marks the end of the historically "best eight months of the year" with the stock market losing an average of 1%, according to Stock Trader's Almanac. The firm expects a "modest correction" in the second and third quarters this year considering the market hasn't pulled back 5% or more this year. The market tracker sees a bear market in "late 2013 or early 2014, when the Fed is likely to begin draining the QE punch bowl and Chairman Bernanke likely steps down." Rising interest rates will stymie homebuying and corporate share buybacks purchased with cheaply borrowed money, which helped drive stock prices higher, the firm wrote in a client note.

Fears of monetary tightening pushed benchmark 10-year government bonds yields north of 2.1% -- a one-year high -- sending the bond market into a tailspin in May. The average domestic taxable domestic bond fund fell 1.70%. High dividend-paying sectors -- utilities and real estate -- that investors had turned to for yield income, lost their allure. They underperformed all sectors funds, tumbling 5.70% and 5.39%, respectively.

But fears of Fed tightening is overblown in the face of slowing economic growth both in the U.S. and globally, says Russ Koesterich, chief investment strategist at BlackRock.

"The upside to slower growth, however, is that it will likely push back any change in monetary policy to the end of this year or early 2014," Koesterich wrote in a client missive. "From an investing perspective, continued easy policy will help mitigate the downside for stocks that comes with slower growth."

Pent-up consumer demand for big-ticket items such as cars and homes coupled with coiled demand from businesses to replace aging equipment and software will continue to drive corporate sales and earnings for the foreseeable future, says James Swanson, chief investment strategist at Boston-based MFS Investment Management with $359 billion in assets under management.

He reasons that the average car on the road is 11 years old and eventually people will have to replace their clunkers, thereby driving up durable goods sales. Car sales have yet to catch up with other goods in returning to prerecession levels.

The number of new homes being built annually remains far below the historic average of 1.5 million a year, according to MFS. New home construction makes up only 2.6% of gross domestic product now vs. 4.5% on average over the past 52 years. And so the industry has plenty of room to grow just to catch up to normal levels, Swanson said in a conference call.

Corporations are holding historically low levels of debt all the while using old factory equipment and out-of-date software and computer systems, which will benefit tech companies, Swanson said. In addition, tech stocks are trading at lower valuations than the market.

Japan Sell-Off

After leading global markets this year, Japan mutual funds sold off the hardest among foreign funds. They lost 6.69% in May, paring their year-to-date gains to 14.07%. The average world equity fund shed 1.19% in May, returning 5.56% year to date.

"This sort of volatility is par for the course given the amount of central bank involvement that's moved the yen as much as it has," said Josh Strauss, co-manager of Appleseed Fund with $300 million in assets. He was referring to the Bank of Japan's epic money-printing program to boost inflation and devalue the yen, which has tumbled 13% against the dollar this year.

As a bottom-up stock picker, he has been buying "global giants that dominate their category" with strong overseas sales and that he believes were "unduly punished" in a broad market sell-off just because they're based in Japan. Japanese exporters are growing sales and earnings while improving profit margins, Strauss said. His fund has less than 5% of assets invested in Japanese companies.

"Viewed from a long-term perspective, Japan is still underowned and undervalued" said James Hunt, manager of Tocqueville International Value Fund . Some 28% of his fund's $236 million in assets is invested in Japanese stocks.

"Japanese companies are cheap on an enterprise value-to-sales and price-to-book basis because their profit margins and returns are not as good as they should be and not as good as comparable companies in the U.S.," he wrote in an email.

"So there is a huge opportunity for corporate management teams to create value by improving profit margins and returns," he added. "Furthermore, most Japanese companies have large net cash positions, which means there is a big opportunity to create shareholder value through stock buybacks and dividends."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing , Mutual Funds

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