For Monday, October 22, 2012, We Recommend Against Investing

Our subjective recommendation has changed.

Technical Comment:

The S&P 500 declined 1.65% on Friday with volume above the 30 day moving average but slightly below Thursday’s volume.  Friday’s decline was large enough to trigger the stop-loss algorithm in our forecasting process.  Should the S&P 500 advance a quarter point (point, not percent) on Monday our forecast will likely return to a growth trend.

Subjective Comment:

A series of poor earnings reports was cited by the financial press as the reason for the large drop in US markets on Friday.  This is of course possible.  Another possibility is the looming uncertainty about the future rate of taxes on capital gains.  The “fiscal cliff” set for January includes an increase in the capital gains tax where the top rate would increase to 23.8%, up from the current 15%.  This will create selling pressure as some people look to sell before the end of the year to avoid the higher tax.  The Eurozone debt crisis remains a serious problem as does the economy of China.  There are significant headwinds, so anything could be the cause for Friday’s decline.

We have been speculating the US markets are about to enter another bubble-boom.  Two weeks ago we saw a big swing in US banking reserves that indicated an increase in the origination rate of new loans.  This past Thursday the banking reserve data returned to where it was a month ago, completely reversing the change we saw.  The US M2 money supply continues to grow in the 7.5% to 8% straight-line annualized range.  This reversal of data on Thursday evening was a surprise to us, and the market drop on Friday also was unexpected.  We have gone back over the data and noticed the jump in the seasonally adjusted M2 data that was not present in the non-seasonally adjusted data.  This happened close to the swing in US banking reserves.  While we will never know for sure, we speculate the swing in US banking reserves 2 weeks ago was erroneous data.  We were ready to believe the swing when it happened given the new indefinite Quantitative Easing from the Federal Reserve.  We also watched the market data for another week and saw multiple strong-volume up-days before we changed our subjective recommendation from “Risk Off” to “Invest for Growth”.  We were attempting to be prudent and not react too quickly.  Perhaps we did.  When we are certain of our opinion, we will express that certainty.  When we have doubts, we will share this candidly with you.

What we are certain of is the price inflationary consequence of the money supply growth rate.  We are also certain of the predictive capabilities of Austrian Business Cycle Theory.  Our forecasting algorithms are our best efforts at predicting the timing of market trends, and this is the part where uncertainty exists.  We recommend investing in price inflation hedges for the long term and avoiding all bonds.  As for investing in US equity markets, this is where we’re not sure about the timing.  We know if the US M2 money supply growth rate remains where it is that the bubble-boom will not resume.  The growth rate must increase if the manipulated boom in the market and economy is to continue.  We think the 2 month zero-growth in US M2 that occurred earlier in the summer is part of the reason earnings appear weak now.  When US bank lending appeared to accelerate, we thought US M2 would respond.  If US bank lending data was inaccurate, then our recommendation must be reconsidered.

The US market is moving sideways with high volatility.  When this happens our stop-loss algorithm tends to get confused and causes frequent changes between a “growth trend” and an “uncertain trend”.  This is what is happening to our automated forecasting process right now.  Additionally, the pattern recognition algorithms have identified nothing of a predictive nature, neither for growth or decline.  There were the beginnings of patterns, but nothing fully formed.

After reviewing all of the data we realize that right now, our recommendation to invest in US equities hinges on US bank lending.  All other indicators do not provide a compelling data set to draw a conclusion.  US Bank Reserves data have either become highly volatile, or there is a data error.  Without any change in the US M2 trend we are inclined to think it was a data error and this is why we’re reversing our subjective recommendation.  It is still possible US banks could accelerate loan originations and cause a rapid increase in the US M2 growth rate, in turn inflating another bubble-boom.  If and when this occurs, that will be the opportunity to invest.  We recommend moving equity holdings back into cash and waiting through the US elections to get a better read on what is occurring.  We will continue to provide daily commentary and will do our best to explain our recommendations, especially when our recommendations change.

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