For Friday, September 7, 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 2% on Thursday with volume above Wednesday and higher than the 30-day moving average.  This was sufficient to change our automated forecast back to a growth trend by reversing the stop-loss trigger in our algorithms.  The S&P 500 would have to decline about 28 points on Friday to change our forecast back to an uncertain trend.

Subjective Comment:

After two consecutive strong-volume down-days, Thursday was a strong-volume up-day for the S&P 500 with the index advancing an impressive 2%.  On a purely technical perspective, the advance on Thursday could be a break-out of sorts.  The market peaked in late March and then declined until the end of May.  Starting in June the S&P 500 began an advance that peaked about 3 weeks ago, almost exactly where it peaked back in March.  A mild decline has occurred during the past 3 weeks and then today the strong advance shot the S&P 500 above the peak from back in March.  This is similar to a “cup and handle” pattern that can be predictive of further market growth.  However, this pattern is usually applied to a single stock and not a market index.  Additionally, our forecast turning to a growth trend today is not based on pattern recognition but on the reversal of our stop-loss trigger.  This break-out it interesting and the trend of the market and money supply needs to be watched closely to determine if the market is at a turning point or not.

The weekly US M2 money supply statistics are available from the Federal Reserve and we have performed our analysis of the growth rates.  From 8/20 to 8/27 US M2 (Not Seasonally Adjusted) fell 30 Billion Dollars, causing the straight-line annualized growth rate over the past 18 weeks to decline to 6.5%.  It had been at 7%.  US banking required reserves have advanced and excess reserves have declined, suggesting US banks may have accelerated lending a bit.  If this trend continues, then US M2 will continue to grow.  US Banks have about $1.45 Trillion of excess reserves.  If they begin aggressive lending they could seriously accelerate the US M2 growth rate.  The Fed Funds rate had been holding very steady at 0.13% for the past several weeks.  On 9/5 it bumped up to 0.16%.  This is likely just noise, but if it climbs a bit further and stays higher, that means the Fed is letting the money supply growth rate slow a bit.

The interpretation of the US M2 money supply growth is very difficult.  The growth rate had been 7% from August last year through late March.  For about 2 months M2 growth collapsed to 0% and then resumed growing near 7% again about 18 weeks ago.  Based on Austrian Business Cycle Theory we think the money supply growth is no longer sufficient to sustain the mini-bubble-boom in the US economy and stock market.  US M2 growth needs to accelerate much more to provide enough stimuli to cause another bubble-boom.  If US M2 growth had remained at 0% the US market would have crashed much sooner than it will with M2 growing near 7%.  A crash will come.  Every bubble is followed by a crash.  Predicting when is difficult.

The US markets advanced today in reaction to the European Central Bank announcing “MOT” (Monetary Outright Transactions).  MOT will be direct and unlimited purchases of Eurozone sovereign bonds by the ECB, focusing on maturities of 3 years and shorter.  This is a bailout of Spain.  Had the ECB done this through Monetization (money printing), then a bubble boom would begin in the Eurozone.  The ECB has been very clear they are conducting MOT via sterilization, meaning no new Euros are being printed.  While it is good new Euros are not being printed, it is very bad for the Eurozone economies and markets that funds will be redirected via the ECB to bailout Spain and other Eurozone countries.  The free market would not purchase these sovereign bonds, so the capital being redirected by the ECB (without printing Euros) will starve businesses and entrepreneurs from funds needed to create a healthy economic recovery.  We think the Eurozone and US markets have reacted to the ECB’s MOT program with the mistaken belief MOT will be some sort of magic fix.  Anyone thinking this does not understand the implications of sterilization and money supply growth.  Unless the money supply growth rates actually accelerate, this bump will not turn into a sustained bubble-boom.

Continue to avoid US equities and all bonds.  Hold and accumulate cash as a wealth preservation strategy.  If the money supply growth rates accelerate you will have time to invest and take advantage of new growth trends.  For now it does not appear money supply growth will be sufficient to drive sustained growth.  With massive excess reserves in both the US banking system and Eurozone banking system it is possible the money supplies could accelerate at any moment.  We think it is better to wait for this to start instead of gambling that it might.  Avoid investing now but be prepared for changes in the future.

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