June risks could cause 'summer of shocks'

Wall Street is eyeing markets in June with suspicion and trepidation as traders monitor a number of potential shocks that could derail stocks this summer.

Investors are on high alert even though the Dow Jones industrial average is coming off its best weekly advance in 10 weeks. The Dow’s 2.1% jump was its best since the week ending March 18.

The angst is driven home by the foreboding language that evokes coming storms used by Wall Street strategists in recent investment reports. Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, warns that markets are entering “event risk June” which could culminate in a “summer of shocks.” The investment team at Cornerstone Financial Partners says the market could be in for a "cruel, cruel summer.”

Are there land mines? "Yes, the potential is there. No doubt we are facing a lot of potential shocks,” Brad McMillan, chief investment officer at Commonwealth Financial Network, told USA TODAY.

The key word, however, is “potential,” as the three shocks McMillan fears could upend markets most are now viewed as low-probability outcomes. But that’s precisely what makes the risks greater: investors are downplaying worst-case outcomes and could be caught flatfooted and improperly positioned.

Adding to the sense of caution is the fact that June is among the worst months for the Dow. Since 1950 it has posted an average decline of 0.3% in June, which ranks 11 out of 12 months, according to The Stock Trader’s Almanac.

McMillan ticks off three things that could cause market volatility to spike in June at a time when stocks are fully valued if not overvalued and corporate earnings are under pressure.

1. Fed rate hikes. The Federal Reserve’s next policy meeting is June 15 and chair Janet Yellen said Friday that it's “appropriate” to increase interest rates “gradually and cautiously…in the coming months.” While investors have come around to the idea that the economy can withstand another quarter-point increase, any signs that the Fed is thinking of following a June hike with multiple additional hikes could upset the bulls.

“There’s a big difference between saying we might (hike) and here we go,” McMillan says. “If they do hike in June then the question becomes do they hike two or three times, not one or two? And that’s a big shift.”

U.S. stocks fell nearly 12% following the Fed’s quarter-point rate hike in mid-December, its first rate increase in nearly 10 years. A similar negative reaction can’t be ruled out, Wall Street pros say.

Jobs report could be key to Fed rate hike

2. Britain bids farewell to EU. The fear factor related to the so-called “Brexit” vote on June 23 has diminished in recent weeks amid polls that suggest Brits will opt to stay in the 28-country European Union. The risk? If investors’ current bet on what Bank of America dubs a “Bremain” is wrong and Britain leaves the EU. Such an event is not currently priced into markets and is likely to cause turmoil and economic disruption in Europe and the U.K. “The market’s looking at Brexit and yawning,” McMillan says. “(Britain) will probably stay, but the market could be wrong and that is the type of Black Swan-event that investors should be looking at but are not.”

3. Jobs and wage surprise. The May jobs report set for release Friday could also upset markets. If the U.S. jobs count comes in weaker than expected, after a disappointing 160,000 new jobs created in April, it could spark alarm that job growth is weakening, which would also negatively impact the confidence of U.S. consumers.

“Two downticks in a row for jobs will rattle investors,” McMillan says. Why? The job market and consumer spending have been two of the bright spots driving the U.S. recovery.

On the flip side, if the job market heats up too much, and puts upward pressure on wage growth, it could raise inflation fears and also spook markets, says Dan Heckman, national investment consultant at U.S. Bank Wealth Management. With commodity prices, such as oil, already rebounding, it could put further pressure on the Fed to raise borrowing costs more aggressively to slow things down.

“Investors will get hit with a left (jab) and a right (uppercut): rising wage inflation and rising commodities inflation,” Heckman says.