For Friday, Nov 18, the market forecast is uncertian

We recommend selling your equity positions.  Avoid money market funds as a cash alternative due to exposure to European sovereign default risk.

Technical Comment:

The S&P 500 dropped another 1.7% on Thursday, and volume was higher than Wednesday and higher than the 30-day moving average volume.  Wednesday and Thursday both experienced market declines on increasing volume, and the 30-day market trend is now negative.  This is the beginning of a pattern that can precede further downward motion in the market, although this pattern is not fully formed.  Thursday’s decline was more than sufficient to trigger the stop-loss algorithm within our automated forecast.  The S&P 500 would have to increase about 15 points (1.3%) on Friday to return our forecast to growth.

Subjective Comment:

Back on both November 1st and 9th the S&P 500 dropped enough to trigger the stop-loss safety setting within our forecasting process and caused our “growth” signal to change to “uncertain”.  On Thursday the stop-loss was again triggered and that’s why our forecast is again “uncertain”.  Thursday’s drop was different from the 1st and 9th.  On those previous days the drop was just enough to trigger the stop-loss algorithm.  Thursday the market drop was much more than enough to set off this trigger.  In addition we have just seen two consecutive days of downward motion on increasing volume.  That also makes Thursday’s triggering of the stop-loss different compared to the 1st and the 9th.  The upward movement needed on Friday to return our forecast to growth is much larger than these previous dates.  With the continued high daily market volatility anything is possible on Friday, either up or down.  We think this forecast flip to uncertain is more significant than the previous two where we advised holding equity positions.  Now might be the time to sell (or move to a risk-neutral position) and hold cash (not mutual funds) for a little while.

It is also concerning to note the S&P 500 closed at 1,216 on Thursday.  Recently on October 21st the S&P 500 broke above the 1,216 – 1,226 range.  Since then it has found support when it has dropped back to this range.  Historical patterns of breakouts above a previous level of resistance with that level then becoming support under the market are positive for growth.  By closing at 1,216 on Thursday this level of support is being tested.  If the market moves up tomorrow, this 10 point range on the S&P 500 will still be a level of support.   If the market closes down instead, it would be a breakdown of the support level and that is a bearish pattern.

We reviewed the updated money supply numbers published by the Federal Reserve.  The graph we published last week shows the same trends this week.  In numbers this trend has shown the following:

  • Prior to June 2011 Seasonally Adjusted M2 was growing at $8.9 Billion a week, and this rate has been consistent for more than 6 months.
  • In June and July 2011 the Seasonally Adjusted M2 grew at $56.9 Billion a week as bank lending significantly increased.
  • Starting in August 2011 the Seasonally Adjusted M2 growth rate has returned to $8.9 Billion a week.

The massive increase in August and September has caused the US economy to begin another bubble-boom.  This is why economic indicators are improving and many US businesses are reporting earnings and profits ahead of expectations.  This bubble-boom could turn into a short blip if the M2 growth remains at $8.9 Billion per week as seen the past 3.5 months.  US banks began aggressive lending in June and July and then abruptly returned to the previous lending rate.  Why?  We’re not sure.  What we are sure about is that these chaotic changes in the M2 growth rate will cause short-term “improvements” in economic and business indicators, followed by slow-downs.  This start-and-stop of the money supply growth will cause havoc with markets and the economy.

Yesterday we speculated quite a bit about the Eurozone crisis.  The news we saw on Thursday did not change our opinions and we encourage you to read this post if you haven’t already done so.  It very much appears the European Central Bank will wait before printing money to address the crisis for political reasons we can only guess at.  This means the Eurozone will continue to put downward pressure on US markets.  We think it is a very good idea to sell your US equities and hold cash while the Eurozone goes through this crisis.  We think the Fed will respond by adding more Dollars to the US banking system despite the eventual price inflation this will cause, but that is a guess.  If they do this, then investing might make sense.  With yesterday and today’s comments we are clearly changing our opinion about the US equity markets.  We thought the M2 growth rates would persist and overtake the downward pressure from Europe.  The revelation that US banks could have up to $1 Trillion Dollars of exposure to European sovereign debt is the new knowledge that has changed our previously bullish opinion.  The $1.5 Trillion of excess reserves in the US banking system is probably viewed as a safety net against European uncertainty, and this could explain why US banks slowed lending and thus the slowing of the M2 growth rate.  Now that our automatic forecast has turned to uncertain following two down-days on increasing volume, we see the near term for US stock markets as likely volatile and plateaued or about to decline for a short while.

Keep watching the US money supply and the ECB’s decision to print (or not print) Euros for indications of what will happen to US markets.  The M2 growth rate must accelerate again if the bubble-boom is going to last longer than several months.  We will continue to comment on developments we are watching and publish our forecast signal to help you decide how best to position your portfolio.