For Friday, May 18, 2012, the market forecast is uncertain

Our forecast for US stock markets is an uncertain trend.  If you choose to liquidate and hold cash, please avoid money market funds as they have exposure to European sovereign default risk.

Technical Comment:

The S&P 500 declined 1.5% on volume stronger than Wednesday and above the 30-day moving average volume.  This makes the 3rd consecutive strong-volume down-day with 7 such negative days in the past 11 trading sessions.  Our forecasting process continues to identify the 50% chance of market growth or decline.  Sideways movement or a strong up-day could fool our stop-loss algorithm and cause our forecast to return to a growth trend, but it would take a strong upward movement in the S&P 500 index for that to happen on Friday.

Subjective Comment:

The Eurozone debt crisis is getting very bad.  Bank Runs are in progress in Greece and in Spain, and this will probably spill over into Italy.  There will be demands placed on the European Central Bank to print money (aka “supply liquidity”) to prevent a banking collapse.  The spill-over is surely part of the influence dragging down US markets.  The Chinese stock market is also declining as economic news across China is very negative.  This is what happens when money is created to fuel bubble-booms.  The booms go bust, every time.  The current bubble-boom in the US is showing signs of weakness as well, as is becoming obvious in the US stock markets and economic news.  Without acceleration in the growth rates of the US money supply we expect US markets to continue a sideways movement or, more likely a decline.

We have analyzed the weekly US money supply statistics published by the Federal Reserve, along with the biweekly statistics on US banking reserves.  First we’ll list the facts and then provide interpretation.  Here is what we noticed:

  • After two weeks of atypical declines, US M2 (Not Seasonally Adjusted) increased $13 Billion for the week ending May 7th.  This is a minor up-tick compared to the decline of $187 Billion for the two preceding weeks combined.
  • Straight line growth for US M2 (NSA) is now down to 7% annualized from last August through early May.
  • The residuals for the two weeks preceding the most recent week presented out-of-control conditions on the control chart we use.  The most recent week came back “in control”, but the data point is just barely above the lower control limit.
  • US M1 (Not Seasonally Adjusted) is a data set with a lot of noise.  Visually there appears to be a slowing growth rate of M1 over the past 2 to 3 months with the past month turning into a zero growth rate.  We have not previously commented on this because it takes a long time for a trend to be noticeable from the variability.
  • Two weeks ago US Banking Required Reserves (NSA) shot up dramatically.  This appears to have been noise as the most recent data is now in line with a flattening trend.  This is happening at the same time as Excess Reserves are decreasing.
  • The Monetary Base (M0) has been virtually unchanged for 10 months when the Federal Reserve ended their 2nd Quantitative Easing program.

The interpretation strongly suggests the Fed is indeed sterilizing its bond purchases with equal selling as they conduct operation twist as shown by a flat M0.  The virtually flat Required Reserves suggests banks have changed their lending trends and are originating fewer net new loans.  This is happening with Excess Reserves declining.  The implication is the Federal Reserve is actually doing more than just sterilizing its bond purchases but might in fact be draining excess reserves from the system.  Another possibility is US banks are growing their loans at a slower rate, thus accounting for the decline in excess reserves.  The flat Required Reserve rate suggests net new loans are not growing at all, but the variability in the data could be obscuring the actual signal.  Whichever it is, the net effect is a slowing of the US money supply growth rate.  The slowing growth rate has been gradual, but it does appear to be there now that several weeks of data are available.

Based on Austrian Business Cycle Theory (ABCT) this is bad news for anyone hoping US stock markets will continue to grow.  The US economy and stock market has been in a mini-boom since the summer of 2011 when annualized money growth was 25% for two months, followed by about 7% annualized growth since.  ABCT explains that an accelerating growth is necessary to keep a bubble-boom going.  A steady growth rate will fail to sustain the boom and that is what has been happening.  The US money supply statistics are delayed by about 10 days when published, and about 10 days ago the political drama in the Eurozone was heating up.  In these past 2 weeks we’ve seen a lot of financial turmoil from Europe and there was the much publicized news of massive losses by JP Morgan Chase bank in the US.  For now the data suggests a gradual slowing of the money supply growth rate.  This will lead to stagnation and decline of the US stock market and economy.  If the money supply growth rate slows even more, then the US is more likely to experience a dramatic crash instead of a gradual stagnation.

Avoid US stocks right now.  Move to a cash or risk-off position.  US bonds have been increasing in price as investors flee into bonds for “safety”.  If you haven’t already sold all your bonds, use this opportunity to get out now.  Price inflation will be coming in the future, and that’s when bond prices will fall.  If the money supply decelerates, price inflation will not be as bad.  Watch the Fed, US bank lending and what happens with the money supply.