Bank of America Strategist Warns of Imminent 'Vortex of Negative Headlines' to Send U.S. Stocks Plummeting
Markets are quiet right now. Too quiet.
The Chicago Board Options Exchange's Volatility Index, a measure of implied volatility, is near its lowest levels of the year. It's been over a month since the S&P 500-stock index moved more than 1 percent in either direction. All the worries that people were really anxious about earlier this year—from rising corporate defaults to a Chinese hard landing and central banks running out of ammunition—have mostly been put on the back burner.
Yet some strategists say this calm belies a storm.
In an appearance on BloombergTV on Monday, Savita Subramanian, Bank of America Merrill Lynch's head of U.S. equity & quantitative strategy, warned of a "vortex of negative headlines" coming in June that could soon push the S&P 500 to 1,850—back near its February lows. Among the factors she cited are the upcoming 'Brexit' vote, the June decision from the Federal Reserve, and the U.S. election.
"We're heading closer and closer to the most polarized election that we've seen in our careers. So there's a lot to worry about," said Subramanian. "One of the things we've noticed is that about six months ahead of November in an election year, the market typically peaks and trends downward."
She added that the Fed is in a tightening mode during a corporate profits recession, which is not typical.
Subramanian isn't the only one to foresee trouble this summer. In a note to clients last week, Andrew Sheets, Morgan Stanley's chief cross-asset strategist, offered a spin on the old adage: "Sell in May and go away."
He noted that getting out of stocks from May through November has "worked" in the past, owing to a few dramatic declines during that period, as opposed to generalized weakness during these months. A better approach, says Sheets, is thus to buy volatility in May.
Like Subramanian, Sheets sees particular reasons to be cautious this year:
"Are there fundamental catalysts that could justify higher volatility this summer? We think so, including: the UK's EU referendum and Spanish elections in June, a China recovery that we suspect may slow by August/September, and our scepticism on the sustainability of the oil price recovery. And structurally lower market liquidity certainly doesn't hurt the case for owning volatility, in our view."
In particular, he likes downside hedges on emerging markets, put spreads on U.S. high-yield debt, and call options on the S&P 500 as a more cautious way to play the long side in stocks.