For Friday, January 27, the market forecast is for growth

We recommend any leveraged ETF that grows with the US market.  Here are some options:

2x Leveraged ETFs

NASDAQ 100

Russell 2000

S&P 500

QLD

UWM

SSO

3x Leveraged ETFs

NASDAQ 100

Russell 2000

S&P 500

TQQQ

URTY

UPRO

Technical Comment:

On Thursday the S&P 500 moved down 0.6% on volume higher than Wednesday and above the 30-day moving average volume.  If the S&P 500 declines about 7 points on Friday (0.5%), our forecast could change to uncertain.

Subjective Comment:

Thursday’s market action was a down-day on higher volume.  One single day of market data is never enough to use for predicting future moves in the market, so one large-volume down-day is not too troubling by itself.  It is the first such day in a long time.  It is rare to have gone so long without such a strong down-day.  It will take more strong-volume down-days to form a signal.  The volume was stronger, but still not very strong by longer term norms.

What we find interesting about Thursday as a strong-volume down-day is it happened the day following the FOMC announcement.  With more time to mull over the text of the announcement and review Chairman Bernanke’s press conference, could it be that market participants have developed some concern?  If so, they will continue to sell their positions and a pattern will develop over the next several days.  Otherwise, Thursday is just a common occurrence within the current bullish trend.

Like every Thursday, the Federal Reserve published updated money supply statistics.  Additionally they published the bi-weekly reserves of depository institutions (US banks).  Two weeks ago we noted a significant up-tick in the M2 money supply compared to the recent straight-line trend.  (It was above 3 standard deviations from the trend.)  We now have three data points to evaluate combined with an idea of how bank reserves have changed, and we may have been too excited about the 1/2/12 up-tick in M2.  We will explain why we are changing our subjective evaluation below, but first we recommend you read this article by Eric Fry at the Daily Reckoning.  It explains how the Fed’s Dollar Swaps with the European Central Bank are back-door bailout loans for Europe.  The timing and amounts of the Dollar Swaps is what we want you to note.

The Seasonally Adjusted M2 jumped up on 1/2/12, but in the past 2 weeks the growth rate of M2 (SA) has returned to the mid-4% range which is consistent with the rate of growth in M2 (SA) prior to the up-tick.  Unadjusted (Not Seasonally Adjusted) M2 had the same up-tick, but since the up-tick M2 (NSA) has declined for 2 weeks.  Turning to the reserves of depository institutions (US banks), the decline in excess reserves appears to be leveling off.  Required Reserves are still growing, but the SA required reserves may have also leveled off.  The NSA required reserves continue to grow at a steady pace since last summer.  The reserves data suggests US banks have not accelerated their originations of net new loans.  The leveling off of excess reserves is likely a result of the Dollar Swaps from the Fed to Europe returning back to the US banking system.  The amount of the Dollar Swaps and the timing could explain why there was a sudden up-tick in the first reported money supply data in January.  Additionally, as we noted last week, the Money Supply statistics “contained significant revisions going back at least 18 months.”  At the beginning of each calendar year the Fed commonly makes adjustments.  We think the timing of the Dollar Swaps, combined with the time it took for those Dollars to come back into the US banking system and the annual data adjustments, contributed to the delay between the Swaps being sent to Europe and the resulting up-tick in the M2 money supply.  We also speculate the Dollar Swaps were bridge loans necessary to bailout Europe while the ECB and the members of the Eurozone came to a working agreement on the 3-year, 1% LTRO loans from the ECB to European Banks.  Now that the ECB LTRO loans are in place, we do not think additional Dollar Swaps will be necessary.

This is why we are revising our subjective opinion.  It appears US banks have not accelerated the originations of new net loans and the US money supply is still growing at the 4% annualized trend with the Dollar Swaps having caused a brief special cause up-tick in the otherwise steady rate.  This means the stock market rally and economic improvements in the US are still being fueled by the burst of lending that occurred back in June and July.  The longer we have money growth in the mid 4% range, the more likely we are to see the simulative effects of last summer wear off.  Given these circumstances we are returning to a more cautiously optimistic stance.  We recommend holding current positions and being prepared to change quickly.  Thursday’s strong-volume down-day is probably just a common blip, but if more strong-volume down-days occur in quick succession it will have to be considered in conjunction with our revised opinion regarding the growth of the money supply.  The evaluation of daily market data is what our automated forecast provides objectively.  We regret our subjective analysis was too quickly swayed by the up-tick in the M2 data and that it took us a few weeks to make the connection with the Dollar Swaps.  We still expect continued strength in the US economy and stock market from last summer’s burst of lending, at least for a while longer.  When the stimulus wears off it will become obvious from the daily market data.

Just a few closing international observations…