The S&P (NYSEARCA:SPY), (NYSEARCA:VOO), (NYSEARCA:IVV) and other stock market indexes basically did nothing in the first quarter of 2014. After the nearly 30 percent return in 2013, most people were expecting a letdown. I and my fund Oxriver Capital, which attempts to time the S&P 500, were bullish, but we held some cash. The fund did this because the portents were good but not ideal, and it targets much less volatility than a passive investment in the stock market over the market cycle. Today Oxriver Capital believes the prospects for the second quarter of 2014 are worthy of a greater than a 100 percent weight in the stock market. We believe that the prospects for great returns are so high that buying on margin or some ownership of leveraged ETFs (NYSEARCA:SSO) makes sense within the context of conservative risk management and an eye towards transaction costs.
Stocks beat analyst expectations for earnings in the first quarter at a greater rate than the last 20 years, according to Reuters. Yet macro data disappointed. The promise of robust economic recovery may have been shrouded by a harsh winter, but there may be other problems.
I believe the S&P 500 will most likely close at 1950 by the end of June 2014. Transitory factors last quarter such as disruptive weather obscured an improving economic environment and strong intermediate-term earnings growth prospects. Rising employment will feed back into increased demand and tax receipts. A stronger fiscal situation in the U.S. will allow fiscal policy to be less restrictive. Thus, the prospect for a correction in this quarter is very small. A much smaller percentage of Americans are invested than before the recession, 52 today percent versus 65 in 2007, meaning that more stock market holdouts are going to throw in the towel and invest after 5 years of good returns since the stock market bottom in March 2009. (You don't contribute to your 401(k) when you are out of work.) With these improving trends, the chances that the S&P 500 will break the psychological barrier of 2000 by the end of Q2 2014 is greater than one in three by the end of June 2014, according to my estimates.
Of course, if earnings disappoint or macro data continues to come in weak, these targets may not be reached. Moreover, investors buying on margin or owning leveraged ETFs will lose more in bear markets than unlevered investors. Stock investing is risky, but diversified holding in the S&P can reduce many of the firm and industry-specific risks. I think too many investors are too acutely focused on the rough markets of 2001 and 2008 to 2009, while ignoring how well stocks have performed over the last century.
The world is always a scary place full of potential problems, and today is no different. In Q1 2014, we had an emerging market scare. Socialist China has reached the limits of state sponsored growth and by even the suspect state measures, the economy is slowing. Russia, as it has for most of my lifetime, is threatening the sovereignty of its neighbors. Could disaster for the U.S. stock market come from weakness in developing economies? That is possible, but it is unlikely. The U.S. is a safe haven from emerging markets. If they stumble, stocks in the U.S. stocks will probably do fine. China has never been a big importer of U.S. goods produced by S&P 500 companies.
Russian aggression has worried many investors. My opinion is that Russia is just being Russia. Did the Soviet Union stop the bull market of the 80s with its hostilities in Afghanistan or its domination of Eastern Europe up to the fall of the Berlin Wall? Did the conflicts in Azerbaijan and Chechnya slow the U.S. bull market of the 1990s? The answer to those questions is, "No." I don't like Vladimir Putin, and I think Russian foreign policy is almost always bad, but it rarely has a meaningful impact on the U.S. stock market. The Russian bear may roar further next quarter, but it is unlikely to stop the stock market's bull run.
Disclosure: I am long SSO, VOO, SPY.
Business relationship disclosure: I manage the hedge fund Oxriver Capital.