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After four straight months of gains, the market’s year-to-date surge of nearly 12% may seem like reason to bust out the fireworks and celebrate. Yet many investors have persistent concerns that higher inflation will force the Federal Reserve to stop buying assets or even raise interest rates sooner than expected. And then there’s one of Wall Street’s favorite sayings, “sell in May and go away,” which suggests avoiding the market altogether until after September.
While worries may be lingering in the background, they’re not being reflected in stock prices right now. What’s more, the CBOE Volatility Index, commonly known as the VIX, is near 2021 lows, which indicates that professional investors are expecting low volatility in the market over the next 30 days.
But look beyond stock prices, and you can find other signs of a change in sentiment. CNN’s Fear and Greed Index has seen a pretty dramatic turn in the past month, from a “greed” reading of 61 to a “fear” reading of 39 on a 100-point scale. Meanwhile, bullishness among individual investors about the six-month outlook for stock prices fell in late May to the lowest level since October 2020, according to the American Association of Individual Investors’ weekly sentiment survey.
Watch for more insight from the Fed’s June meeting about any potential change in monetary policy ahead, and keep an eye on major economic data releases to better understand the current state of inflation.
Waiting for the Fed to Change Its Tune
The Federal Reserve is scheduled to convene for one of its eight annual meetings on June 15-16. As with recent meetings, market participants don’t expect any major changes to monetary policy, meaning policymakers are likely to leave interest rates at near-zero and continue buying $120 billion of bonds each month.
At some point in the next few months, Fed policymakers will need to shift their messaging, notes Jay Hatfield, founder and CEO of Infrastructure Capital Advisors. That’s because the central bank’s stance that inflation is “transitory” is increasingly at odds with its action of continuing to buy bonds, which increases the supply of money in the economy—and can fuel inflation, he says.
“The idea that they’re not going to taper and inflation is transitory is not sustainable,” Hatfields says. While policymakers may “stick to their guns” through summer when it comes to the current messaging, he believes they’ll either back off their claim of inflation being temporary or begin to get the market comfortable with the idea of tapering bond purchases, he adds.
“Fed watching is always critical,” Hatfield says. “If you get Fed policy right, you get the market right” in terms of the direction it’s headed, he adds.
Ernesto Ramos agrees that the messaging out of the central bank will begin to shift in the months ahead. The minutes from April’s meeting showed that the topic of tapering was broached, so that question of when it starts will come more into focus, adds Ramos, the chief investment officer of BMO Global Asset Management.
“I think that’s going to be more and more a topic of conversation,” Ramos says. And it’s bond purchases, rather than raising interest rates, that will be the Fed’s first priority, he notes. For now, traders only see a 7% likelihood of a rate hike by year-end, and policymakers have promised to keep rates low for the foreseeable future.
Key Economic Data: PCE Inflation, Jobs and GDP
Speaking of inflation, the market will get a peek at the Fed’s preferred measure of prices—the May Personal Consumption Expenditure Index (PCE)—on June 25. The 3.1% gain in April Core PCE inflation, which excludes the more volatile food and energy costs, was higher than economists forecasted but less than some people on Wall Street had feared.
Neither Ramos nor Hatfield believe that higher inflation is going to be temporary, as the Fed has repeatedly promised. “We see the potential for bad news on the inflation front,” Ramos says. Hatfield adds: “We’re bearish about inflation; we think it’s going to accelerate, not decelerate.”
Even sooner, Ramos says the monthly jobs report for May, scheduled for release on June 4, could be “a pretty interesting day” for the market. That’s because the report for April showed a huge slowdown in hiring, so investors will be watching for whether some hiring spilled over into May, which would be “really good news, economically speaking,” he adds.
A strong labor market, however, could drive yields on the benchmark 10-year Treasury bond higher and cause stock market investors to continue to favor value stocks in lieu of growth stocks, Ramos notes. Coupled with the pace of economic growth and relative optimism among U.S. consumers, the jobs report could also give more credence to the inflation-is-here-to-stay argument, he adds.
Consumer confidence, for instance, held steady as of late May, above the pre-lockdown levels, according to the weekly Ipsos-Forbes Advisor U.S. Consumer Confidence Tracker.
Meanwhile, Hatfield says he’s monitoring the price of oil, which he sees going to as high as $80 a barrel by summertime from the current mid-$60 range. So-called trevelgeddon, a surge in travel that’s expected this summer, could also see the average price of a gallon of gas reach as high as $4, from just over $3 currently, he adds.
Finally, Hatfield says he checks a gross domestic product (GDP) forecasting tool from the Atlanta Fed on a daily basis. Currently, that’s estimating second quarter economic growth of 9.3%.
How to Invest in June
Inflation remains the key issue for the market, and inflation jitters are likely to keep the S&P 500 in a pretty tight range until early July, Hatfield says. Come July, companies will start reporting earnings results for the second quarter—until then, Hatfield doesn’t believe the S&P 500 will go much beyond 4,200.
What’s more, there’s no clear catalyst to drive the market much higher in the short-term, according to Ramos. “What other good news could keep driving the market higher?” he says.
In the near-term, Hatfield says value stocks remain more attractive than growth stocks. And Ramos says an allocation that’s “a little bit” more exposed to small caps makes sense because those stocks are more economically sensitive.
Finally, Ramos says the market is “ripe for some volatility” in the summer, and potentially a market correction, though investors can’t predict the cause right now. “Something out there will create turbulence at one point or another,” he says.
Ramos recommends holding off on making any moves until at least the jobs report on June 4. If that report exceeds economists expectations, then invest in value stocks. If it comes in lower than expected, put your money to work in growth stocks, he recommends.