For Tuesday, July 24, 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 0.9% on Monday with volume below last Friday but above the 30-day moving average.  Another S&P 500 drop of about 16 points (-1.2%) on Tuesday would likely be enough to change our automated forecast to an uncertain trend.

Subjective Comment:

The market drop was much larger at the opening of Monday’s trading session.  The Eurozone debt crisis continues to create financial drama.  Greece might or might not get a third bailout.  If not, Greece defaults on August 20th.  Spain’s various political regions are teetering near bankruptcy which is driving Spanish bond yields up to almost 7.5%, and anything over 7% is considered mathematically unsustainable for Spain by many analysts.  The European Central Bank appears unwilling to provide bailout funding, showing the Long Term Refinance Operations (LTRO) loans from earlier this year only kicked the can down the road a few months.  There is no other entity able to bailout Spain.  We expect increased volatility from Europe to bleed over into US markets.  The technical pattern in US daily market data remains weak with large declines on reasonably strong volume.

We have commented many times about the tremendous amount of excess reserves in the US banking system.  There are just under $1.5 Trillion of excess reserves that US banks could lend anytime if they decided to do so.  The Federal Reserve is paying 0.25% interest to US banks to hold these reserves on deposit at the Fed, which is about $37 Billion in risk-free profits per year.  US banks would need an incentive to change from the current situation, and today a Keynesian economist, Alan Blinder, suggested the Fed lower the interest they’re offering to zero percent.  Mr. Blinder went on to suggest charging 0.25% if the zero percent rate fails to motivate US banks to lend.  Creating $1.5 Trillion Dollars via Quantitative Easing was crazy enough, but the banks NOT lending has kept price inflation somewhat in check.  If the Fed follows Mr. Blinder’s advice we would see a sudden growth in the money supply.  It would reignite a major bubble-boom and drive stocks and other prices much higher.  The resulting price inflation would be unthinkable.  If this happens, our investment advice would change quickly.  For now, we have not seen any change so our advice remains to stay out of the US stock markets, avoid all US equities and all bonds.  Hold your price inflation hedges for the long term and hold cash.  Acquire cash and begin researching price inflation hedges you would be willing to accumulate in case the Fed follows Mr. Blinder’s insane advice.  At some point we fear the Fed might do something very similar to Mr. Blinder’s suggestion.  We hope we’re wrong.

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