Stocks ended last week on a high note, closing a smidge above strong resistance at 1900 for the S&P 500, which set a new closing high for the large-cap index, albeit on low pre-holiday volume. With the Memorial Day holiday giving us a short week of trading, all eyes are on voting in Ukraine, where a decisive win for billionaire business tycoon Petro Poroshenko seems assured. The only question is how Russia and the breakaway eastern regions will respond this week.
Meanwhile, over in Western Europe, surprising election strength from anti-EU, anti-euro, anti-austerity, anti-immigration, anti-Islam, and anti-Semitic parties from the far right and far left all won seats in countries like France, Britain, Greece, Denmark, Holland, and Hungary.
Among the ten U.S. business sectors, defensive sector Utilities is still the clear leader year-to-date, up nearly +10%, but it has pulled back significantly during the month of May. Energy and Healthcare are now in a dead heat for second place YTD, and Technology is finally making its move. Tech was quite strong last week, up about +2.5%. Consumer Services/Discretionary remains the laggard, but even it is approaching the breakeven mark YTD.
Rather than bond prices falling, the 10-year Treasury yield remains at a low 2.54% and still shows no inclination whatsoever to rise. As the Federal Reserve tapers its bond purchases, there has been no widely-expected Great Rotation out of Treasuries. In fact, PIMCO bond guru Bill Gross is actually predicting that long-term yields will fall even further, primarily because the all-time high in global debt will keep global growth quite slow over the next few years. The yield curve is already flatter than most observers expected it would be, and Bill Gross is expecting it to get even flatter. As a result, he also thinks it will be several more years before the Fed can start to raise short-term rates. And of course, low long-term interest rates support higher equity valuations because the comparative earnings yield threshold is lower.
The CBOE Market Volatility Index (VIX), a.k.a. fear gauge, closed last week at 11.36, which is a new 52-week low. It continues to creep downward, indicating investor complacency about risk in their stock holdings — and perhaps an expectation of a low-return, low-volatility trading environment for the foreseeable future. As it continues to move lower, some observers are predicting that a single-digit VIX is in the offing, but others are saying that a sudden spike (correlating with a big fall in equities) is far overdue and imminent.
Notably, Bank of America Merrill Lynch put out their global research report about the four-year presidential cycle, and the midterm election year (which we are in right now) is typically the weakest. They observe that an intra-year decline of at least 20% has occurred 43% of the time during midterm election years, compared with a 27% likelihood in any given year since 1928.
Indeed, investor sentiment has become notably bearish, as the AAIA investor poll of bullishness is at pessimistic extremes and the 10-day Put/Call Ratio is at its highest level of bearishness since last summer. But from a contrarian perspective, both of these are historically bullish for equities. Moreover, the BAML report also observes that the midterm election year typically turns quite bullish come September.
