For Friday, July 13, 2012, We Recommend Against Investing

We recommend selling your equity positions or hedging for a risk-neutral position.

Technical Comment:

The S&P 500 declined 0.5% Wednesday with volume above Tuesday but below the 30-day moving average.  Another decline on Friday of about 3 points (-0.2%) would likely be enough to change our forecast to an uncertain trend.

Subjective Comment:

Thursday was a strong-volume down-day.  The technical market weakness continues and now the formation of a predictive pattern has begun.  Predictive patterns frequently begin their formation but fail to fully develop into any predictive value, but the beginning of a weak pattern is another sign of weakness in the market technical indicators from our forecasting process.

Euro Money Supply:

Late last week the European Central Bank (ECB) lowered the interest it pays on the deposits it holds for European banks to zero percent.  This is an incentive to encourage banks to resume lending and cause the Euro money supply to grow via the fractional reserve money multiplier.  The initial results were a dramatic drop of 60% of the Euros from the ECB Deposit Facility! (data here)  In one day, European banks withdrew €484 Billion Euros, drawing down the deposits from €809 to €324 Billion Euros.  This is equivalent to $590 Billion US Dollars, over half a Trillion Dollars!  (Hat Tip Zerohedge.com)  This is a huge change and potentially highly inflationary for the Euro money supply.  If European banks lend this cash, then the Eurozone is about to begin another bubble-boom.  The other huge unknown is if the ECB will sterilize the money multiplier impact and keep the Euro supply growth rate small.  The ECB publishes money supply statistics monthly, and then only for the prior month.  It will be almost 2 months before the Euro money supply statistics show with certainty what will happen.  Close attention must be paid to European markets for signs of strength.  Should a rally start in Europe with strong-volume up-days, this would be an indication of a rapidly expanding Euro supply.  This could reduce some of the spill-over impact on US market participants.  It is not at all clear what will happen.  European banks are all near bankruptcy, so they may be inclined to hold their cash or find somewhere else to park it, so a money multiplier growth spurt may or may not happen.  All that is certain right now is the dramatic change in the ECB deposit facility and the need to watch developments carefully.

US Dollar Money Supply:

There was some indication the cash from Euros might have found its way into the 10-year US Treasury auction yesterday (July 11th, 2012).  If the source of the record setting US Treasury auction was European banks moving their money from the ECB deposit facility, this will not have a direct impact on the US money supply.  To use Euros to buy US Treasuries requires first buying those Dollars in the foreign exchange market, so the US money supply is not directly impacted.  However, if US Dollars that have been in Europe (often called Euro-Dollars) were purchased and sent to the US, the result could be price inflationary although Euro-Dollars are statistically part of the M2 money supply.  Should US banks begin lending to create US money supply inflation by the money multiplier effect, the question is what will the Federal Reserved do in response?  The Fed Funds rate has been holding constant as money flows from Europe to the US has occurred for the past several weeks.  (data here)  The only way the Fed Funds rate is held constant is by the open market operations by the New York Federal Reserve Bank either adding to or removing Dollars from the money supply.  US Bank Required Reserves are remaining flat, and the Excess Reserves continue a downward trend.  (data here)  This highly suggests there has been an inflow of Euro-Dollars, causing the Fed to drain reserves to hold the Fed Funds rate constant.  As long as the Fed continues its current operations, the US Money Supply will continue its recent trends.

We analyzed the weekly US M2 money supply (not seasonally adjusted) data published today.  The straight-line growth is subject to fluctuations as there are only 17 weeks in the most recent trend.  What was a zero percent growth rate has now crept up to an annualized 1.2% over the past 17 weeks.  This is normal statistical fluctuation with all 17 weeks remaining inside the residual control chart we use for detecting changes to trends.  Simply stated, the growth rate of the US Money Supply remains near zero for the past 3+ months.  This is no change in the growth rate.  Since the 10 months prior had an annualized growth rate of over 7% this current trend means a crash is coming to the US economy and stock market.  The economic slow-down is already manifesting itself in economic indicators.  Using Austrian Business Cycle Theory to interpret this data provides a clear conclusion of the pending crash.  The exact timing is difficult to guess subjectively as there are too many economic factors to consider and it is impossible to know what decisions will be made by US banks and the Federal Reserve.  The capability for either to initiate a rapid money supply expansion is ever present right now.  Should economic indicators get worse the Fed might react.  If they wait too long their actions will not be soon enough to prevent the decline we see coming.

Summary:

If you hear about the LIBOR bank rate scandal, please know we see it as a distraction and of little significance.  It will be a very big deal for the poor scapegoats who might be sacrificed.  Here’s more information on LIBOR and why it is not a big deal to US investors.  LIBOR will not be the cause for the coming crash in US markets, but it might offer a convenient excuse to distract attention.  The US money supply growth rate has collapsed after years of growth.  The mini-bubble-boom in the US economy and stock markets has ended as a result.  There might be time to delay the crash if the US M2 money supply resumes rapid growth, but we see no indication this will happen.  The ECB zero percent interest has created a very unpredictable situation for the Eurozone, so spillover effects in the US are equally unpredictable right now.  We continue to advise holding and accumulating cash.  Avoid US stocks and all bonds.  Hold your price inflation hedges.  Only add to price inflation hedges if you have done more research on specific opportunities.  Remember, we offer advice based on our technical analysis and subjective interpretation on the money supply.  You have to make your own investment decisions.  We also work for tips.  Please consider giving us a donation or perhaps recommending us to your friends.

3 Responses to For Friday, July 13, 2012, We Recommend Against Investing

  1. Following up…
    So far it appears European Banks are keeping their cash and not lending it out. The ECB deposit facility that now pays 0% interest is an overnight deposit where the next morning all funds are moved back into C/A holdings. Imagine you have a savings account and checking account. Your bank offers a great interest rate on your savings account, but every day you have to move money into the savings account to get the interest overnight. The next morning your bank moves the money back into your checking account. In this analogy, the ECB deposit facility is the overnight savings account and C/A holdings is the checking account. So far, European banks have simply stopped moving their money from the C/A holdings into the ECB deposit facility each night. The money has not moved, at least not yet. It’s just in a different account.

    (Hat Tip Zero Hedge: http://www.zerohedge.com/news/clarifying-entirely-unremarkable-shift-ecb-deposits)

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