For Tuesday, October 2, 2012, We Recommend Against Investing

Market conditions are changing.  Please read our entire post to fully understand our current recommendation and the potential for changes in the near future.

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Technical Comment:

The S&P 500 advanced 0.3% on Monday with volume below Friday but above the 30 day moving average volume.  The S&P 500 index would have to decline about 12 points on Tuesday (-0.8%) to trigger our stop loss algorithm and change our automated forecast to an uncertain trend.

Subjective Comment:

Monday’s index advance on the S&P 500 does not technically qualify as a strong-volume up-day by our data processing because the volume was below Friday.  However, the volume was very, very close to Friday’s level and was above the 30-day moving average.  We think the S&P 500 is at a turning point.  It is typical at turning points for patterns of weakness and strength to develop.  Sometimes the turning point is a period of sideways movement before the market changes its direction.  At other times the turning point is a period of sideways movement followed by the market resuming the same trend.  Based solely on the technical analysis from our proprietary algorithms, we are unable to predict if the next trend will be up or down.

The US money supply provides the additional context for us to subjectively opine about the future direction of the US market, and it appears the S&P 500 is about to break to the up-side.  The M2 growth rate has been growing for the past 4 months at about 8% annualized.  There was a 2 month 0% growth which put bubble-growth at risk, and that is why economic indicators have been weakening lately.  It’s probably also why there has been some market weakness in the past 2 weeks even though QE3 was announced.  Last Friday we commented about the first $20 billion of QE3 money leaving the Federal Reserve.  We also noted that the Federal Funds rate had declined to 0.14% after about 3 weeks at 0.15% to 0.16%.  The data for Friday’s Fed Funds rate has been published and it dropped to 0.09%!  Large drops like this do occur in the Fed Funds rate, but when they do the New York Fed usually takes action to price fix this interest rate back to their desired target.  However, with the new QE3 money entering the system the NY Fed will find it difficult to keep the Fed Funds rate from dropping like this when the QE3 money leaves the digital printing press at the Fed.  In the past large swings in the Fed Funds rate are typically reversed within 3 days.  If the Fed Funds rate does not go back up to where it was, that will not be enough to suggest acceleration of money supply growth, but it certainly creates the circumstances that encourages US banks to accelerate new loan originations.  If the Fed Funds rate shoots back up, which would suggest the New York Fed is attempting to fix a higher rate, and that in turn would have a sterilizing effect offsetting QE3.

The Fed’s QE3 should accelerate the US M2 growth rate to near 12%.  If US banks accelerate lending then M2 should grow faster than 12%.  With the indefinite time horizon for QE3 we could see US banks change their behaviors.  We are waiting for clear confirmation the next S&P 500 trend will be an uptrend before changing our subjective recommendation, but the data developing points more and more to an uptrend.  Price inflation hedges continue to be a very good investment, but be sure to hold those for the long term and do your own research to identify the options best suited to your situation.  Also, continue to avoid all bonds.  Bonds will fall in price when interest rates rise, and eventually rates will go up as they have very little room to go much lower.  The data release this Thursday after the market closes combined with the Fed Funds rate for the next few days could very likely change our recommendation to a investing for market growth.  Move the cash you consider available for investing into your brokerage accounts to be ready to invest as early as the market open this Friday.

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