For Wednesday, December 14, the market forecast is uncertain

We recommend selling your equity positions and holding cash, or otherwise moving to a risk-off position.  Avoid money market funds as a cash alternative due to exposure to European sovereign default risk.

Technical Comment:

The S&P 500 dropped 0.9% on Tuesday with volume higher than Monday and above the 30-day moving average volume.  The high volume was just barely above the 30-day moving average.  The moving average volume has been declining for quite a while.  Two days ago the average was higher than Tuesday’s volume.  The 0.9% drop in the index was enough to trigger the stop-loss algorithm in our automated forecast.  This is why the forecast is now uncertain.  On Wednesday if the S&P 500 closes up more than just 1 point (0.001%), our forecast could likely flip back to growth.

Subjective Comment:

As we have commented many times recently, high volatility in the S&P 500 market index can cause our forecasting system to flip between growth and uncertain.  The close proximity of the index to our stop-loss trigger means our forecast could not only flip back to growth tomorrow if the market goes up, but that we could see several days of forecast flipping if the market bounces up and down from here.  The stronger volume on Tuesday was just a little above the moving average, so we don’t read anything into Tuesday’s volume by itself.  We do want to mention that over the past 4 trading days we have seen the beginning of a pattern that can predict further market weakness.  This pattern is not fully formed, but it is developing.

It is curious that US markets opened strong and then turned down sharply to close down for the day.  While it is impossible to know for certain, we will hazard a guess.  We noticed that 2:09 pm the S&P 500 began its decent from 1,245 to negative territory within 30 minutes, followed by continued declines through the end of the day.  At roughly the same time or slightly before the Federal Reserve published their FOMC comments from Tuesday’s meeting.  The Fed did not change their monetary policy in any way.  There had been some speculation that QE3 might be coming from the Fed, but most of that speculation was for an announcement early next year and not on Tuesday.  Our best guess is the absence of more money printing now from the Fed and from the European Central Bank is causing concern with more and more market participants.  This is probably why the market began its decline immediately after the Fed’s FOMC announcement.

Here are the reasons we are turning bearish regarding the near term prospects for US markets:

  • The ECB did not respond to the Eurozone crisis summit last weekend with a clear announcement of Euro printing.
  • Without Euro printing from the ECB, there will be sovereign bond defaults possibly as soon as the first half of 2012.  France, Italy, Spain and other countries have large amounts of bonds maturing that must be refinanced over the next several months, and only Euro printing from the ECB can fund this.
  • The Federal Reserve has not announced QE3, at least not yet.
  • US banks are holding their excess reserves.  They engaged in a burst of lending back in June and July last summer, causing US M2 money supply (seasonally adjusted) to grow by over $500 Billion in about 8 weeks.  This burst of lending caused a mini-bubble-boom in the US economy and put upward pressure on US stocks.  This growth rate collapsed back to about 5% annualized for the past 17 weeks, removing the artificial stimulus.
  • We speculate US banks are holding the excess reserves as a contingency to their exposure to European debt.  As such, they are unlikely to resume lending until they feel safe the Eurozone debt crisis has been resolved.
  • Finally, we’re starting to see patterns in the daily S&P 500 market data that are typical of weakness as discussed above.

For these reasons, we advise against investing in US stock markets.  Do not hold your money in money market funds as they have exposure to European debt.  Even if volatility in the market index causes our forecast to flip back to growth, we will continue to advise a risk-off position until we see signs of serious strength.