For Friday, October 5, 2012, We Recommend Investing for Growth

Market conditions have changed and so has our investment recommendation.

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Technical Comment:

The S&P 500 advanced 0.7% on Thursday with volume above Wednesday and higher than the 30 day moving average volume.  If the S&P 500 declines about 21 points on Friday (-1.4%) our forecast could change to an uncertain trend.

Subjective Comment:

We are changing our subjective forecast.  We are no longer advising our readers to Hold Cash.  Our point of view has now changed and we recommend Investing for Market Growth.  We have been discussing the potential for changing our recommendation over the past few weeks and today we have seen data that changes our opinion.

First we will comment on our automated process: Thursday was another strong-volume up-day for the S&P 500 market.  Our automated process has not detected a fully formed pattern that would predict market growth nor market decline, but the accumulation of strong-volume up-days is an indication of an up-trend for the market.  Our technical analysis does not show a signal at this time, although our automated forecast has been showing a Growth Trend for a while now.

The weekly money supply data was published on Thursday along with the biweekly update of US banking reserves.  US M2 money supply has been growing at 7.5% annualized for 21 weeks.  So far there is nothing in the US M2 money supply itself to indicate an acceleration of growth.  So far QE3 has not had a noticeable impact on US M2.  There does appear to be some sterilization of QE3 based on the Fed Funds rate remaining at 0.15% to 0.16% as well as the graph below.

What has caught our attention and is the primary reason we are now recommending investing in US equities is the jump up in the US Banking Required Reserves.  Required Reserves show the net lending of US banks.  When they are steady, banks are originating new loans at the same rate as old loans mature, and this has been the case since January.  We now have the first data of Required Reserves following the QE3 announcement, and they jumped about $15 Billion in 2 weeks.  For the past 3 months there is now a straight-line growth rate of just below 50% annualized for Required Reserves.  The actual growth rate for Required Reserves could be much higher based on the past 2 weeks.  This is a clear indication that US banks have accelerated their lending, and it is very reasonable to conclude this is in direct response to QE3.

Below is a graph of Required Reserves and Excess Reserves.  Required Reserves are what US banks must hold based on their loan portfolios.  Excess Reserves are the reserves US banks hold in excess of the minimum required.  Excess Reserves have dropped.  Part of this is the actions by the New York Fed to maintain a fixed Fed Funds rate, but most of the drop comes from the accelerated bank lending.  US banks still have over $1.35 Trillion of excess reserves, so they will be able to continue lending aggressively for quite some time and appear willing to do so with QE3 in place.

Federal Reserve data published 10/4/12; H3 Table 4

It might be just a little early to go all in with your investment portfolio, but indications are pretty clear that US banks are going to accelerate lending as a result of QE3.  This will eventually drive up the US M2 growth rate and in turn cause another asset bubble-boom for the US economy and stock market.  There are still risks from the Eurozone debt crisis.  The European Central Bank today left their rates unchanged and have not yet started their own accelerated money printing, so continued weakness in Eurozone stock markets and economies is to be expected.  China will also continue their economic contraction and stock market decline as the People’s Bank of China has greatly slowed the growth of the Chinese money supply.  Also remember the possibility of geopolitical shocks that could spook the market.  Any of these events could cause a bumpy US market.  As long as US banks keep lending at this new accelerated rate any dips will be short for US markets.  Over the next 2 to 4 weeks we see more data that will further confirm what we are now seeing.  It is very important to note the decisions made by central bankers and commercial bankers are what will drive the US market, and this small group of people could choose to change.  For this reason continued vigilance watching the daily market data and weekly money supply is absolutely necessary.

Despite these risks, we recommend investing in US equities.  It is necessary to invest to stay ahead of the price inflation that will result from the aggressive money creation from the Fed and the Fractional Reserve Money Multiplier.  We encourage the use of leveraged index funds to grow your investments faster than the market itself.  This should help you stay ahead of price inflation for now.  Price inflation hedges should continue to be held and considered a part of your overall portfolio.  Continue to avoid bonds and decide for yourself how much of your investable cash you want to move into the market.  Here are a few leveraged index funds to consider adding to your portfolio: RSU, SSO, SFLA, UPRO