For Thursday, March 8, 2012, 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 index rose 0.7% on Wednesday with volume below Tuesday and lighter than the 30-day moving average volume.  The upward movement of US markets on Wednesday was a bounce after a much larger decline on Tuesday.  The light volume associated with Wednesday’s advance is itself a weak sign following the strong-volume decline.  The past 6 trading sessions have seen 3 strong-volume drops and a weak-volume advance, resulting in a net decline.  This is a weak market pattern.  No patterns are available to predict the future direction of US markets.  The S&P 500 would have to advance about 5 to 6 points (0.4%) on Thursday for our forecast to return to a growth trend, but this would be a reversal of our stop-loss algorithm and not necessarily a sign of market strength.

Subjective Comment:

On Wednesday US markets opened up slightly and then jumped up mid-morning, holding steady the rest of the day after the mid-morning advance.  The cause of the jump was an article published by the Wall Street Journal (WSJ) discussing potential actions of the Federal Reserve.  According to the article, the Fed is considering a bond buying program called Sterilized Quantitative Easing.  Unlike the previous two rounds of QE that added over a Trillion Dollars to the money supply, “Sterilized” QE would buy bonds using funds borrowed from the US banking system.  This would move existing money around, but it would not add to or reduce the size of the money supply, and that’s why it’s called “sterilized”.  By not adding to the Fed’s balance sheet the Sterilized-QE would not be inflationary.

A few days ago we opined that most market participants have a basic understanding of how QE lifts markets, but they lack a full Austrian Business Cycle Theory (ABCT) understanding of this process.  Today’s market advance following this WSJ article supports this hypothesis.  Market participants reacted to the “Quantitative Easing” phrase without understanding what “sterilization” means.  Sterilized-QE, if truly sterilized, adds no new money to the money supply.  To the extent the current growth rate of the money supply is unchanged or slows, Sterilized-QE will do nothing to prevent the crash that will occur now that the bubble-boom has begun.  Please note, we are not forecasting when the crash will happen.  ABCT clearly explains that every bubble-boom is followed by a crash.  We remain concerned the crash is drawing near as the money supply growth rate has remained unchanged for the past 7 months following the rapid expansion last summer.  Tomorrow the weekly money supply statistics will be published by the Fed and will offer the next opportunity to see if the growth rate remains steady or has changed.

The Fed has the most control over the growth rate of the US money supply, but currently US banks have the ability to grow the money supply if they accelerate originations of new loans.  They have $1.58 Trillion Dollars of excess reserves of which they are required to keep only a 10% fraction.  This means the fractional reserve money multiplier can add over $15 Trillion Dollars to the current $9.7 Trillion M2 money supply.  The potential for an extreme inflation exists and could be unleashed at any moment.  The fact this has not happened means US banks are nervous to lend, and we still think the Eurozone debt crisis is most likely their top concern.  Keep in mind Greece is facing a technical default on March 20th, so the next few weeks could be very interesting and highly volatile for US markets.

We continue to recommend holding cash or a risk-off position relative to US stocks.  Do not park your cash in money market funds as they have exposure to European debt and could lose value.  Absolutely sell your bond holdings.  As price inflation gets worse bond prices will fall as investors will demand a higher bond yield (interest rate) to compensate for price inflation.  We will continue to report what our automated forecast signals, and please remember high market volatility can cause our stop-loss algorithm to be frequently fooled into switching between a growth-trend and uncertain forecast.  Subjectively, we think it is best to wait out the current Greek bond crisis before getting back into the US market.

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