Mid-Month Update: Dreary Summertime Outlook
By: Christopher Mistal & Jeffrey A. Hirsch
June 16, 2016
June’s Triple Witching option expiration week (or Quadruple if you prefer) has a history of choppy performance. The week has historically been rather volatile with frequent moves in excess of one-percent in both directions. This volatility has been evident this week. Add in a Fed meeting and the upcoming Brexit vote and it becomes clear why the market appears to be on edge.
Yesterday’s Fed announcement drew attention not for its lack of action, but because of the reduced growth forecasts that accompanied it and an apparent disconnect over inflation expectations. Reduced growth is not that large of a surprise especially considering the Fed’s recent track record of being overly optimistic. What is somewhat concerning is the Fed maybe missing the big picture when looking at inflation. It would not be the first time for this either. Longer-term expectations do not appear that stable.
[Michigan inflation expectations] 
In the short-term, energy and housing have been giving CPI and PCE (Fed’s preferred metric) a boost, but longer-term expectations are falling. Since peaking in April 2011, the University of Michigan’s Inflation Expectations survey has been in a steady down trend. It was at 4.6% then and the most recent reading was 2.4%. But, this is just a survey and can be dismissed. However, what cannot be ignored are the negative 10-year bond yields in Japan, Switzerland and now Germany. There has also been a meaningful drop in U.S. yields. Undoubtedly, some of this distortion is the result of central bank policy and a flight to safety, but it also seems to be a clear signal that longer-term inflation expectations are also moving lower.
There is plenty of research that concludes the lack of inflation, or worse deflation, is simply not good. One only needs to look up the Great Depression for further detail. The real issue is the nearly obvious fact that low interest rates and quantitative easing did not/does not work all that well. It may have staved off the Financial Crisis and kept economies from falling off a cliff, but it has failed to spark sustainable growth. Growth has stalled, corporate earnings are flat-lining and real wages are shrinking which is not the best recipe for continued stock market gains. Sideways to lower is more likely.
Next week’s Brexit vote is important for more than just the citizens and residents of Great Britain. Should they vote to leave the European Union, it is a vote to undue decades worth of work and cooperation and a blow to globalization. Will Great Britain be better off or worse should they leave? Only time will tell. If they are worse off, it will likely be business as usual for the rest of the world’s economies. However, if they are better off, it could mean a significant change in the global economy as other countries will likely follow suit and take similar isolationist moves.
No New Highs & A Meager Summer
Having already issued our Seasonal MACD Sell Signals for DJIA, S&P 500 and NASDAQ, we are largely out of harm’s way. Exposure to equities has been trimmed, and depending on personal risk tolerance, you are in cash, bonds and a handful of bearish positions or some combination thereof. Our Stock and ETF Portfolios are positioned with a combination a few select longs and a number of defensive positions.  
In all likelihood the worst case scenarios presented elsewhere will not unfold. End-of-Q2 portfolio window dressing and concerns over the Brexit vote will probably be the catalyst that keeps next week’s streak of market loses intact. DJIA has registered a loss in 23 of the last 26 weeks after June option expiration. Another weekly loss and the then known result of Brexit will likely have taken investor sentiment sufficiently bearish to setup a tradable rally into the first half of July just as the Presidential conventions kick off.
A fickle Fed, mixed economic data and a volatile political and geopolitical arena are likely to keep the market at bay for the remainder of the year. We expect the averages to fall short of new highs and drift lower through the later part of the summer and early fall, likely testing and potentially breaching the lows of last August or earlier this year. Any yearend rally is likely to be contingent upon who wins the White House. 
History suggests that a win by an untested, unorthodox and unfamiliar candidate as Mr. Trump will be a drag on the market as uncertainty will permeate The Street. Contrary to popular opinion and regardless of your political beliefs, the market is likely to rally more on a win by Mrs. Clinton because it knows what it’s dealing with – a continuation of much of the current administration’s policies.