For Monday, August 20, 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 0.2% on Friday with volume below Thursday and lighter than the 30-day moving average.  A decline on Monday of about 15 points (-1.1%) would likely be enough to change our forecast to an uncertain trend.

Subjective Comment:

While the US stock market continues to advance, it does so with weak volume.  This is concerning as it is usually much better to see a rally occur on strong volume.  The S&P 500 has reached the level where it peaked back in April.  If the S&P 500 continues to advance above the April level this would be a good technical indicator.  It is also possible a decline from here could occur which would form a “double top” pattern that can predict decline.  All this past week trading volume has been very light, so it is not at all clear if the rally will continue or not based purely on the daily data and technical patterns we watch for.

The US M2 money supply has resumed growing at a 7% annualized rate after having collapsed to a 0% growth rate for the months of March, April and May.  It is telling that the S&P 500 peaked back in April, which was the second month of the 0% growth rate.  The simulative impact of the growing money supply was puttering out, so the collapse to 0% is why the US market declined and bottomed out at the end of May.  The resumption of the 7% growth rate then caused the current market rally to resume.  The week-to-week variability in the US M2 data series had us concerned the 0% growth rate might have been persisting or a slower growth rate had resumed.  Now that more time has passed we’re able to see the growth rate did in fact return to an annualized 7% rate in June.  It appears the cause of the collapse to 0% growth was the Fed’s decision to allow the Fed Funds rate to double from 0.08% to 0.16% from January through April.  Starting in May the Fed fixed the Fed Funds rate at the 0.16% level instead of letting it continue to increase, and that required a resumption of digital money printing.  In mid-July (about a month ago) the Fed lowered the Fed Funds rate from 0.16% down to 0.13% where it has been holding steady since.  This required a brief acceleration of money printing.  Since US Banks are still not increasing their loan portfolios, the only source of net money growth has been Fed policy vis-à-vis the Fed Funds rate.

With US M2 growing again at the same rate prior to the 3-month no-growth period, it is possible the US stock market could continue weak growth for a few months from here.  The US economy remains very weak and will not show signs of significant improvement as long as M2 is growing at the 7% rate.  If M2 starts growing above 10% then the US economy could start to experience another bubble-boom and stocks could show more growth.  At the 7% money supply growth rate the US stock market remains very fragile and susceptible to world markets, particularly the Eurozone markets and China.  We expect China will crash in the near future, but the Eurozone could crash or boom depending on what the European Central Bank does.  If the ECB starts aggressive Euro-printing, the Eurozone markets will boom and this will lift US markets.  If the ECB continues to hold Euro monetary policy as tight as it has been for the past several years, the Eurozone debt crisis will continue and markets will be flat or fall.

The resumption of a 7% US M2 money supply growth rate means price inflation will continue.  When the US money supply growth had dropped to zero, we advised holding but not accumulating hedge positions to protect against price inflation.  Now that growth is back at 7% we are again advising the accumulation of price inflation hedges.  You must do your own additional research to determine which types of hedges are best suited to your position.  We also recommend against all bonds, including TIPS and regular US Treasury bonds, municipal and corporate bonds, and bonds from other countries.  When interest rates increase in the future, bond prices will fall.  When companies and cities go bankrupt, they will default on their bonds.  Our automatic forecast suggests US market growth will continue, but we subjectively advise against investing in US equities as we think the US market remains fragile.  If US M2 begins growing greater than 10% and the ECB starts printing Euros, we would very likely change our recommendation regarding US equities.  Since US equities remain very susceptible to upward or downward forces, we continue to advise holding cash or a risk-off position.

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