For Tuesday, December 20, 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 1.2% on Monday with volume lighter than Friday last week and below the 30-day moving average volume.  The S&P 500 index would have to increase about 15 points (1.3%) on Tuesday to cause our forecast to switch back to growth.

Subjective Comment:

A one-day market decline on light volume would not be concerning in a strong bull market, but US markets are not currently strong.  The light volume on Monday picked up a lot in the last hour in which the index moved sharply lower.  Most of the selling was concentrated during the last hour, suggesting the selling was indeed strong once it started.  Signs of market weakness are persistent, but our forecasting algorithms are not yet predicting a decline.

Last week we presented what’s becoming called the backdoor bailout by the European Central Bank.  This is getting more attention in the financial press, including an interview of ECB President Mario Draghi by the Financial Times.  In the interview he admits that banks taking the cheap loans from the ECB could use the funds to purchase bonds, although he stressed the independence of banks to do anything they want with ECB loans.  As market participants are becoming aware of this backdoor bailout, there are more articles and blog postings offering opinions about the viability of this funding to “fix” the Eurozone debt crisis.  We have presented our opinion of how it could work, but there are differing opinions of how it will fail.  To clarify our position, we do not think this backdoor bailout will “work” to “solve” the Eurozone debt crisis.  Excuse the cliché, but more debt is not the solution to a debt crisis.  We do think it could successfully kick the can down the road, but for how long we’re not sure.  Probably not very long, but that depends on the amount of Euros the ECB is willing to print, meaning non-sterilized monetization of debt.  Only if US banks think their risk of losses has been mitigated will they resume lending in a sufficient amount to keep a manipulated bubble-boom going in the US.  Eurozone bond auctions might give a clue if the backdoor bailout is working, but it will not be for a few weeks until the ECB balance sheet data is available before it will be known how aggressively the ECB is printing new Euros.  If US banks wait to see the ECB balance sheet for confirmation the backdoor bailout will work, then there will be a delay until they resume lending.  This is what we think is most likely to happen, which translates into little to be bullish about for the rest of December.  Additionally, the end of the year is always a tricky time with US equity markets as many market participants engage in selling and buying motivated by tax strategies and the need to show the best quarterly and annual investment results.

While the market waits to see if the ECB backdoor bailout will work, there is the possibility other shocks could trigger a sell-off.  The death of North Korea’s dictator Kim Jong Il will probably not be such a trigger, but a collapse in the economy of China would be very negative.  There is plenty of news available that suggests China’s centrally-planned economy is heading for a collapse as predicted by Austrian Business Cycle Theory.  The Chinese have been printing money for years and still are, but they have slowed down the growth rate because price inflation is causing many social problems.  The money printing has enabled massive misallocation of resources into investments whose asset prices will collapse due to a lack of demand.  Do a web search for video or news articles on Chinese Ghost Cities for more information, or see this post at  China shows what happens as a result of massive money printing.  Eventually the growth rate of the money supply must slow to combat price inflation, and that causes the manipulated economic bubble-boom to go bust.  If the money printing keeps accelerating, the result is hyperinflation and a complete collapse of the currency.

We continue to see risks and no clear sign the latest attempt to deal with European debt has worked.  Continue to hold cash.

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