For Friday, August 10, 2012, We Recommend Against Investing

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

Technical Comment:

The S&P 500 advanced 0.58 points (+0.04%) on Thursday with volume below Wednesday and lighter than the 30-day moving average.   If the S&P 500 drops about 30 points on Friday (-2.2%) our automated forecast could change to an uncertain trend based on the settings of our stop-loss algorithm.

Subjective Comment:

The light volume and flat movement in the S&P 500 index on Thursday continues to show a lack of strength following the pattern that predicts growth.  We are suspect of the predictive pattern identification from last week given the weak-volume growth that has occurred in the past several days.  We continue to watch closely for indication of strengthening growth in the daily market data but we have not seen it yet.  From our technical analysis alone we would not yet recommend investing in US markets until a stronger-volume rally presents itself.

In addition to the technical analysis we consider the growth rates of the US money supply and use Austrian Business Cycle Theory to predict what US markets will do.  The challenge is identification of the US M2 (not seasonally adjusted) growth rates.  This is tricky because there is noise in the weekly data published by the Federal Reserve.  The weekly update was published on Thursday and we performed our analysis.  By using control chart techniques on the residuals from straight-line growth we are able to do a reasonably accurate job identifying turning points in trends.  There is room for subjective error in this part of the process, but any error is generally minor enough to be immaterial to the analysis.  Based on the current data, here is a chart with our best estimates of the US M2 (NSA) annualized growth rates over the past two years:

Over the past 4 to 5 months US M2 growth has slowed.  Either the average growth rate has been about 3% annualized over this period, or it was 0% and then 6.2% annualized.  We think after almost 3 months at zero growth it resumed growing at 6.2%.  Either way, the net effect has been a sever slowing after almost a year at 7.3%.  Austrian Business Cycle Theory (ABCT) explains that a bubble-boom can only be created and sustained by an accelerating growth rate in the money supply.  Last summer the 24% annualized growth followed by 10 months at 7.3% provided the acceleration to give us the bubble-boom.  Around March is when US M2 growth collapsed from 7.3% to 0%.  M2 is now growing at either 3% or 6.2%, we’re not entirely sure which.  Either way the money supply growth is NOT accelerating.  This means the bubble-boom has run out of stimulus to keep going.  Any growth from here will be spill-over from Europe should the European Central Bank accelerate the growth of the Euro supply, which seems more and more likely based on the comments of European politicians and bureaucrats.

If US M2 continues to grow at a rate below 7% we can expect any US market growth to be short-lived.  If M2 is growing at 6.2% we can expect price inflation to speed up and the US stock market will likely bounce around and then decline.  If M2 growth is in the 3% range, we expect US markets to enter a decline sooner and the crash to be more dramatic.  Price inflation will still be a problem thanks to the prior money creation courtesy of the Federal Reserve.  Given this uncertainty, we are revising our estimate of when US markets might begin a decline or crash phase.  We had been estimating 1 to 3 months based on the 0% to 3% growth rate for M2.  If M2 is growing around 6% the market decline could be anywhere between 1 to 6 months.  Many other factors will influence timing.

We continue to advise a risk-off position regarding US stocks.  Avoid the stock market in order to preserve your wealth.  Also, avoid all bonds, and we mean ALL bonds.  We suggest doing more research on price-inflation hedges to determine what would be best for your situation.  Consider doing research on agriculture, energy and other commodities.  Real estate is probably not a good idea, but we admit our price-inflation advice is outside our area of expertise.  Generally speaking, we are suggesting adding to your price-inflation positions as an alternative to accumulating cash.  If you’re not comfortable with this, then holding and accumulating cash is still a good strategy to avoid a portfolio decline associated with the stock market.