For Wednesday, October 3, 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 0.1% on Tuesday with volume below Monday and below the 30 day moving average volume.  If the S&P 500 declines about 9 points on Wednesday (-0.7%) our automated forecast could change to an uncertain trend based on the current settings of our stop loss algorithm.

Subjective Comment:

Our automated forecast remains susceptible to false changes between a growth and uncertain trend when the market moves sideways with high volatility.  This could happen given where the market and our stop loss algorithm settings currently are.  The light volume on Tuesday did not contribute to any meaningful pattern formation and the future of the market remains unclear when considering only our technical analysis.

The monetary situation remains supportive of asset bubble creation and we could be nearing a breakout point of strong market growth in the US.  However, the Fed Funds data has been updated for the weekend and through October 1st.  The decline in the Fed Funds rate to 0.09% persisted through the weekend and returned to 0.15% on Monday.  This jump back to 0.15% for the Fed Funds rate strongly suggests the New York Fed is still targeting a rate of 0.14% – 0.16%.  The rate dropped on Friday to 0.09%, most likely from the $20 Billion of QE3 money created and released by the Fed.  The return on Monday to the higher rate is interest rate fixing via open market operations, meaning the NY Fed had to remove some money from the US money supply to get the Fed Funds rate back up.  This is a partial sterilization of the new QE3 money.  Reggie Middleton has provided an analysis suggesting the primary (unstated) goal of QE3 is to increase the profitability of home loans for banks and mortgage companies.  Intended or not, Mr. Middleton presents data that confirms home loans, even at these very low rates, have indeed become much more profitable for banks than prior to QE3.  If his supposition is correct, then it would make sense that the NY Fed is continuing to maintain the pre-QE3 target for the Fed Funds rate.

There are two conclusions to draw from this speculation.  The sterilization by the NY Fed via open markets operations could mitigate the acceleration of US M2 money supply growth, which would mean the direct impact of QE3 on assets and stock prices would be minimal compared to recent history.  This could result in stagnating prices or a resumption of weak growth with susceptibility to external shocks from the Eurozone debt crisis and geopolitical events worldwide.  The other possibility is the increase in mortgage profitability for US banks could greatly incent the acceleration of loans.  Remember, US banks have just under $1.45 Trillion Dollars of excess reserves (Trillion with a “T” – not a typo).  With that much money available to lend and highly profitability in the mortgage market, QE3 could indirectly ignite accelerated loan originations, in turn causing very strong growth in the US M2 money supply.  That would create significant bubble growth in the US economy and asset markets, including the stock market.

This is why we continue to be cautious.  It is not entirely clear if the US M2 money supply is about experience acceleration above its current 8% growth rate.  We continue to watch the data and follow commentary for insight.  The update this Thursday will have data that is about 10 days old, but that will be data a week following the QE3 announcement.  Thursday evening could see a change in our subjective investment recommendation, so be prepared with cash in your brokerage account.  In the meantime price inflation hedges remain a good long-term investment.  Continue to avoid all bonds.

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