S&P 500 Summer Forecast - Part I: Obstacles Cleared

| About: SPDR S&P (SPY)
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The first five months of 2014 were plagued by obstacles for the S&P 500 Index.

Capital flows, harsh winter weather, the Russian aggression and the Fed's fumble in forecasting the Fed Funds Rate all hampered the market's progress.

Each of these obstacles have now been overcome and some of them have turned into fuel, so the index and the ETF tracking it are now set to soar.

The S&P 500 Index is set to soar starting in June 2014. In fact, the run has already begun, with the SPDR S&P 500 (NYSEARCA:SPY) higher by 1.4% through the first week of June. Important obstacles that have held the index back this year and have produced several pitfalls seen the chart below, have now been cleared away. In fact, recent central bank actions have greased the way further. Passive investors can benefit through holdings in the SPDR S&P 500 ETF .

6-Month Chart of SPY at Yahoo

The Obstacles That Have Been Cleared Away

  1. Capital outflows at start of the year as investors protected capital after 2013 gains
  2. Cold snowy winter impacted economic activity and weighed on stocks
  3. Russian incursion into Ukraine produced some volatility & flight to safety
  4. Yellen's Fed published expectations for higher Fed Funds Rate in 2015

Factor #1 Capital Flows

On New Year's Eve, rather than celebrating with champagne, bells and whistles, I was busy writing a report that was appropriately published ominously close to 3:00 AM ET on New Year's Day. Within that report entitled Expect January Ill-Effects this Year, I presciently forewarned of an early 2014 market sell-off. I was working diligently into the night because I was confident stocks would suffer to start the year and I wanted to precede any sign of decline with my forecast. The factor that drove the turmoil that followed is perhaps still not understood by many, but it is detailed within my article linked to above here.

The catalyst for stock market demise, and also the early 2014 rise in gold, was capital flows. Many investors still do not realize or understand this fact. The SPDR S&P 500 ETF performance in 2013 accurately captures the big move made by stocks generally. The SPY appreciated by 32% in 2013 after adjustment for dividends and splits. That represents significant capital appreciation for one year's time, and so some profit taking after the turn of the tax year for individuals should have been expected. Apparently, though, it was not, as the early market issues of 2014 seemed to catch the pundits (other than your author) by surprise.

Likewise, the same capital flow factor came into play for gold and the relative securities that capture it like the SPDR Gold Trust (NYSEARCA:GLD). In contrast to stocks, gold declined in 2013, and so tax losses were taken toward the close of the year. Gold and the securities that track it like the SPDR Gold Trust were therefore trading at a discounted or attractive value to start 2014, and presented a place for capital running out of stocks to run into. This move was also forecast early by your author.

By now, though, as we near the mid-point of the year, this capital flow factor has been well exhausted and is no longer a barrier for stocks. It is not the type of factor that is cured overnight, but rather fades with time. As capital once again seeks better returns, there are few investment options that attract capital as well as stocks do. Historically speaking, most investors agree with the investing greats and with Ibbotson's historical tracking that equities outperform over the long run. Also, as pension fund monies and other capital continues to flow into portfolios, it must be put to use by portfolio managers, and their fund charters dictate much of that capital moves into equities. Likewise, the upward early move in gold prices and the relative securities that capture it like the SPDR Gold Trust begins to lose its fuel as time fades the catalyst.

Factor #2 the Weather

As 2014 progressed, harsh winter weather paralyzed the nation in a deep freeze and buried America's shoppers and purchasing managers in snow. At first it seemed it would be just an excuse used by corporate America's laggards to explain shortfalls, but before long, it began to show up in economic data. The early pressure upon stocks and the lift under gold were supported by real economic concerns now. Though, the economic issues had not yet been conclusively attributed to the temporary factor of the weather, giving stocks all the more reason to fail. As long as there was concern about the economy past Q1, stocks would be weighed down. Eventually, the weather was given all the blame and most economists are now looking for a special lift for Q2 due to pent-up demand built up during the frigid first quarter. Thus, factor #2 is now cleared, or even better, has turned into fuel for the S&P 500 through Q2.

Factor #3 Russian Aggression

On the Friday that closed out trading for February, when Russia began the covert portion of its incursion into Crimea; when unmarked and heavily armed and well trained gunman took control of important facilities and locations in the region, stocks rallied. Those who claim the Ukrainian crisis did not affect stocks nor gold prices point to this fact and other events as evidence of the region being a non-factor for U.S. stocks. What those skeptics never understood, not even to this day, was that it was never the Ukraine that mattered, but Russia and how the West might counter it.

Global progress and civilized trade as we know it become threatened when nuclear powers oppose one another. If Russia were to move past Crimea and attempt to annex a greater portion of Ukraine, it was unclear what the West was willing to do in response. NATO raised the level of its discussion and other former Eastern bloc nations worried about their own security. Beyond military confrontation, there was then and remains today the risk of Russia confronting the West's sanctions against it using the means it has available, which include energy supply to Ukraine and to Eastern Europe for one. It could theoretically cut off the flow of energy and impact the euro, in my view, which threatened the European economy and supported gold prices as well.

During the geopolitical crisis, on days when it seemed a new cold war was at hand or when it seemed a real war might break out between Russian and Western forces in Europe, those were the times gold and stocks reacted. As long as there was no threat to the U.S. or Europe and the issue was contained to Ukraine, traders saw no threat to critical economies nor U.S. stocks, and so they were unaffected. On pivotal days like when Russia annexed Crimea without a significant Western response, stocks rallied. And just recently, when the Ukrainian elections went off without Russian intervention (Russian troops even pulled back off the border), stock started the latest rally that seems to ensure this geopolitical factor has lost its punch, at least for awhile.

Factor #4 The Fed Funds Rate Forecast Folly

When Janet Yellen's Federal Reserve published its economic projections in March, it offered FOMC member expectations for the Fed Funds Rate that showed a majority of the members anticipated higher rates in 2015. Bear in mind that this is the rate the Fed controls, so it seemed to be effectively communicating its plans to raise interest rates at a time that was apparently too soon, judging by the market reaction that day. The SPDR S&P 500 fell by a half of a percentage point that day. Now, Chairperson Yellen did her best to quell market concern by indicating that Fed expectations do not necessarily translate into Fed plans, but the damage was done. If interest rates were going to rise within nine months time at the earliest, then the bull market may be on borrowed time.

In Fed speeches that followed, the tone grew ever more dovish, especially because of the softness of the first quarter. And just this past week, Charles Evans, President & CEO of the Federal Reserve Bank of Chicago, gave a speech in Istanbul Turkey that many found very dovish regarding the future of the Fed Funds Rate. The presentation of the Chicago Fed boss conveyed a message indicating that 2016 was the target for optimal Fed rate hike. If there was any doubt heading into last week, because Yellen had been very vocal since the March mistake, Charles Evans seemed to erase it completely. So, factor #4 is effectively neutralized along with the other obstacles to market growth.

Part II of this two-part series will cover recent events that seem to grease further market gains and what we might expect moving forward to help the S&P 500 rise or fall. Though, it should be clear to the reader, that with these four obstacles removed, the market has clearly been given its marching orders to move forward. Thus, I suggest investors buy the SPDR S&P 500 ETF to benefit from that expected upward move.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.