Market Insider

Traders on the New York Stock Exchange
Source: NYSE

Stocks are likely to reach new highs in June, but the extent of the market’s gains depend on how much a threat inflation becomes and whether it will prompt the Federal Reserve to discuss tightening policy.

June is historically a weak month for stocks, when looking back over the last 20 years. But Instinet points out that the S&P 500 has had a better track record recently, gaining every June since 2016. Over 20 years, it averaged a monthly decline of 0.6%, and was negative 11 times.

Instinet also notes that over the course of the 20 years, the S&P 500 tended to be higher in the first half of the month before dipping to a multi-month low in the second half.

The S&P 500 started off the first trading day of June with a bounce, shooting to within 4 points of its all-time high of 4,238. But by afternoon, it was negative, closing down 2 points to 4,202.

The benchmark sits less than 1% from its intraday all-time high.

The biggest worry for stocks has been inflation, and the recent readings for inflation have all come in higher than expected.

“I really think it’s all about inflation, inflation, inflation and rates, rates, rates,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.

Market focus is already on the June 15 and 16 Fed meeting, viewed as the most important market event this month. The May employment report Friday and inflation measures, like the consumer price index, will also be important.

Strategists say the market could hit new highs but it could be choppy if inflation runs hotter than expected or the Fed begins to sound more hawkish.

Inflation is a double-edged sword for stocks. On one hand, companies that can pass along higher costs in the form of higher prices have pricing power and that can help earnings grow. But if inflation gets too hot, it can eat away at profit margins. If it keeps rising, it can prompt the Fed to raise interest rates, which increase borrowing costs for companies and threaten returns for growth stocks in particular.

Morgan Stanley chief U.S. equity strategist Mike Wilson notes that the June 10 release of the consumer price index could be a key date for the market this month.

“Inflation expectations have also increased beyond what may be achievable in the near term. Inflation is on the upswing in our view and will eventually surpass the Fed’s targets on a sustainable basis,” noted Wilson. “However, expectations have increased too and now price this rise in many asset markets.”

Wilson said the CPI release may be a “sell the news event that could negatively affect many crowded trades.”

So far, the Fed has said inflation is transitory, and price data looks hotter because it is being compared to a weak period last year. But the concern is if it is not, the Fed will have to act to stop rising prices. That means it could start to pare back its bond buying sooner than expected, and ultimately raise interest rates sooner as well.

“I don’t think you’re going to prove until the fall, where inflation is,” said James Paulsen, chief investment strategist at Leuthold Group. “If it’s still hot into the fall, we have a problem. I think odds are low on that. Everybody knows we’re going to get hot inflation numbers. We know why at least in part.”

Paulsen also does not expect the stock market to pull back until the fall, at the earliest. He said valuations should be helped by much stronger earnings growth, and he expects economic data to start coming in better-than-expected.

Scott Redler, partner with, expects the S&P 500 to trade to new highs in June, but he said the market is tentative ahead of jobs data. “The market is waiting to see what is going to happen with the jobs report Friday,” he said.

The Fed has emphasized it will be patient, keeping its policy easy as the labor market and economy heals. Treasury yields have been trapped in a range, below early April highs, in part due to the April jobs report and other data that missed expectations. The benchmark 10-year was at 1.60% Tuesday. Yields move opposite price.

A comment on labor, however, from St. Louis Fed President James Bullard, however, surprised some market pros.

Bullard told the Financial Times that even with the economy down 8 million jobs, the labor market could be tighter than it looks. If so, that would suggest the Fed could be on a faster track to raise interest rates than expected. Economists expect 674,000 jobs were added in May, up sharply from the 266,000 gained in April, according to Dow Jones.

Quincy Krosby, chief market strategist at Prudential Financial, said a weaker jobs number may ironically be more favorable for the market. “If we have a weaker number, not as strong as the market expects, we could have new [stock market] highs,” she said. “That suggests the Fed remains steadfast.”

But she said the market could be spooked if inflation is higher than expected, and it raises speculation the Fed may begin to slow its asset purchases.

The Fed last year changed its policy on inflation so that it now tolerates a range for inflation, where it can run above its former 2% target for a while. Winding down the bond program is seen as a first step toward the Fed raising interest rates, which most strategists don’t expect until 2023 at the earliest.

Lately, Fed officials have said they expect to begin discussing the tapering bond purchases at upcoming meetings.

“They’ve already offered language about the potential to discuss the pace of monthly purchases. Any language that intensifies that is going to be picked up by the market,” said Prudential Financial’s Krosby. “The market is vulnerable to understanding the timetable of how the Fed is thinking and how the Fed interprets the data.”

Marc Chandler, chief market strategist at Bannockburn Global Forex, said the tone of the market heading into June remains “risk on.”

 “I think that’s what the currency markets are saying. Sterling made a new 3-year high. The Canadian dollar made a new 4-year high. Gold has rallied,” he said. “The underlying tone of the dollar is weak. That tells you it’s risk on.” He said risk assets, like stocks, should continue to do well unless yields start to rise too much.

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