For Thursday, December 15, 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 again on Wednesday, closing down 1.1%.  Volume was higher than Tuesday and above the 30-day moving average volume, resulting in two consecutive days of market declines on increasing volume.  With the continued decline in the market, the S&P 500 would have to move up about 1.2%, or 14 points on Thursday to flip our forecast back to growth.

Subjective Comment:

We remain bearish on US markets for the near term for reasons outlined yesterday.  Nothing on Wednesday changed our outlook, but there is a very interesting forecast on developments that could develop over the next several weeks.  The following comes from Robert Wenzel at, and we think it is a very likely scenario.  Included below are additional points we have identified in our previous posts, but credit must be given to Mr. Wenzel for the thesis.


Now for Mr. Wenzel’s thesis and forecast:

  • Germany’s reactivation of the rescue fund combined with the ECB’s lowering of reserve requirements will combine to give European banks sufficient capital to purchase new bonds issued from the various over-indebted nations.
  • By easing the collateral requirements and initiating the long-term loans, the ECB will accept from banks the newly purchased bonds as collateral for loans, creating the funding necessary for banks to buy more bonds and repeat the process.  This will be very profitable for the banks as they can borrow at low rates from the ECB to buy higher yielding bonds, and then repeat the process as long as the ECB continues to provide these loans.
  • As the ECB runs out of sterilization capacity, it will have to print money to fund this on-going back-door support of bond buying by banks.  The unsterilized money printing directly increase the Euro money supply which can be further compounded by fractional reserve lending.  As the Euro supply grows, the new money will cause a bubble-boom in the Eurozone and European stock markets as predicted by Austrian Business Cycle Theory.  It will also cause high price inflation in the Eurozone.

If correct, this process will first see the economic conditions in Europe deteriorate further before the expansionary money printing begins to lift the economy.  Should this play out as described, our best guess (and this is very hard to forecast with accuracy), is it would be around the middle of 2012 before the Eurozone debt crisis begins to abate.  A decrease in the downward pressure from Europe and a decline in the default risk of sovereign debt would allow US banks to then lend at a faster rate, in turn growing the US money supply and igniting a bubble-boom in the US economy and markets.  Should the US Federal Reserve initiate QE3 early in 2012, that would add more fuel for an expanding US money supply.

We find Mr. Wenzel’s argument compelling.  If it plays out, the first reliable data to corroborate the thesis would be the Euro money supply statistics and the ECB’s balance sheet growing.  US banks will eventually figure this out, and in turn will begin lending at a much faster rate.  That will show up in a declining excess reserves and growing US money supply statistics.  In the near term this scenario will not boost markets.  This hypothesis, if accurate, would cause markets and the economy to begin improving early to the middle of next year.  We will continue to watch the daily market data and money supply statistics closely.  Tomorrow’s money supply update from the Fed will likely not show a change in the recent growth rate.  It will be several weeks before this theoretical scenario would start to have an impact.  Continue to avoid long investment positions.