June Weakness (Lee)

June Weakness

Equity Markets Hit Critical Support Zone
Alfred Lee, CFA, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management
alfred.lee[at]bmo.com

June 15, 2011

Recent Developments:

• Over the last several weeks, global equity markets have softened given a number of headline items. First, the price of credit default swaps (CDS) or the cost to insure Greek sovereign debt continues to climb, leading investors once again to focus on the European issues that remain. Secondly and more importantly, global investors are concerned that without a third round of quantitative easing (QE3), equity markets will falter considering the recent economic data that suggests the U.S. recovery is losing steam. With China focused on taming inflation and Japan still struggling from the Tohoku earthquake/tsunami, sentiment has turned amidst concerns that the major engines to economic growth are stalling.
• Undoubtedly, markets and sectors around the globe have softened and the S&P/TSX Composite has been no exception, trading near its 200-day moving average (MA), a key technical-support level (Chart A). To note our TrendSpotter Model shows very few areas outside of bonds that are not indicating weaknesses. While we don’t subscribe to the notion that “sell in May and go away” is a strategy that can be implemented thoughtlessly year after year with success, we do acknowledge that equity markets tend to exhibit seasonality effects. Over the last ten years, June has, on average, been one of the weakest months in terms of monthly performance (Chart B). The question is whether the recent weakness is due to the effects of stimulus wearing-off or just seasonality kicking-in.

Potential Investment Opportunity:

• Without a question, the market is weak over the shorter-term trading and investment cycle. However, we view markets on multiple time-frames, with the key horizon at present being the longer-term cyclical cycle and whether the market has entered a sustained bear market.
• One indicator we monitor is the NYSE Margin Debt levels. Should this indicator cross below its 12-month MA (Chart C), we would aggressively pare back equities. Although the availability of the indicator data lags, it still provides clues for equity and fixed income allocation decisions, especially since its year/year rate of change has a strong tendency to go parabolic at the end of an equity market bull-run. Since it was still significantly above its 12-month MA at the end of April, without showing a parabolic move, we believe this to be a bull-market correction.
• Since many major global equity markets sit near key support levels, we remain cautious as significant drops below the 200-day MAs would be seen as extremely short-term bearish, potentially impacting sentiment of longer-term cyclical investors. For the time being, we would be paring back risk assets and rotating into more defensive sectors such as utilities or shorter-term bonds. However, we would be watching for potential bargains that may present themselves as a result of the sell-off and then look for momentum indicators to turn back up. In addition we would recommend reassessing the market later in the month for seasonality effects as July and August have historically been stronger months.
• The Equal Weight Utilities Index ETF (ZUT) and BMO Short Corporate Bond Index ETF (ZCS) are potential ETFs for investors that may want to quickly reposition their portfolios temporarily for equity market softness while waiting for the cyclical bull-market to ensue.

Chart A: S&P/TSX Composite Drops Below 200-Day MA

Source: Bloomberg, BMO Asset Management Inc.

Chart B: June Has Historically Been a Weaker Month

Source: Bloomberg, BMO Asset Management Inc.

Chart C: Margin Debt Still Well Above 12-Month Moving Average

Source: Bloomberg, BMO Asset Management Inc.

*All prices as of market close June 13, 2011 unless otherwise indicated.

Disclaimer:
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

BMO ETFs are managed and administered by BMO Asset Management Inc, a portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.