For Friday, November 9, 2012, We Recommend Against Investing

Technical Comment:

The S&P 500 dropped 1.2% on Thursday with volume below Wednesday but above the 30 day moving average.  The stop loss algorithm remains triggered, causing our automated stock market forecast to remain at an uncertain trend.  Should the S&P 500 advance about 1.2% on Friday our forecast could change back to a growth trend.

Subjective Comment:

The S&P 500 index has sharply declined for two consecutive days.  Thursday was on volume stronger than the 30 day average but not above Wednesday’s volume, so only Wednesday was classified a strong-volume down-day by our software that detects patterns in the daily market data.  Regardless, the two consecutive days on above average volume is clearly a sign of market weakness.  It is not a good time to invest in US markets and even if our automatic forecast changes on Friday we are unlikely to change our subjective recommendation.

The European Central Bank left interest rates unchanged and has not initiated any serious form of unsterilized monetary expansion (money printing).  This will be health for the Eurozone in the long run, but only if the ECB never expands the Euro supply again.  The chance of that is exactly zero since printing money is the purpose of a central bank.  In the meantime the Eurozone will continue to experience the bust phase of the business cycle brought on by the past money printing by the ECB.  Eurozone stocks will continue to decline and the various countries will experience economic recessions.  This will put downward pressure on US stocks.

The results of the US elections pretty much guarantee taxes will increase in January, including the likelihood of an increase on capital gains taxes.  This will create some selling pressure for US markets as some investors decide to sell before the end of the year.  Also, the stock of Apple has been declining.  Most mutual funds and hedge funds own Apple and are likely to unload their Apple holdings to avoid further losses.  Apple has been a visible leader among stocks, so selling of its shares could cause some sympathetic selling if investors and fund managers get spooked.  There is plenty of conjecture regarding the two consecutive days of steep decline following the US elections.  The exact trigger is a guessing game, but the proximate cause would seem to be the elections.

U.S. M2 Money Supply data was published Thursday and we’ve analyzed the growth trend.  Non-Seasonally Adjusted M2 continues to grow near 8% annualized based on a straight-line curve fit over the past 27 weeks (6 months).  Last week it appeared the Fed Funds rate might be creeping upwards, but since hitting 0.18% on Halloween it has been brought back down to the 0.16% to 0.17% range by the New York Federal Reserve’s trading desk.  We had speculated last week the NY Fed might have been counteracting the effect of QE3 by letting the Fed Funds rate increase, but evidently that is not the case.  There are no out-of-control conditions on the residual control chart we use to track US M2 growth, but a visual pattern of a slight up-trend is present.  Even so, the U.S. M2 (NSA) growth remains right around 8%.  This will not be sufficient to reignite a bubble-boom in the US economy, although the US housing sector will likely benefit since the Fed is purchasing Mortgage Backed Securities with the freshly printed QE3 money.  We’re not convinced this money growth rate will be enough to lift US stocks and the overall economy.  Instead we think the economy and US stock market will stagnate for a while.  If the M2 growth rate remains at 8% or slows, eventually the market will crash.  The only way a market rally will happen is if the growth rate accelerates.

Austrian Business Cycle Theory (ABCT) explains how a bubble-boom occurs in response to a growing money supply.  The money supply growth must accelerate to keep a boom going.  To put the 8% growth in perspective, here has been the history of US M2 growth for the past 2.5 years:

  • June 2010 – June 2011 – Annualized growth at 6.8%
  • June 20th, 2011 – August 15th, 2011 – 2 months of Annualized growth at 24%
  • August 2011 – March 2012 – 7 months of Annualized growth at 7.3%
  • March 12, 2012 – May 7th, 2012 – about 2 months of 0% growth
  • Since May 2012 – 8% Annualized growth

In the summer of 2011 the 2 months of 24% annualized growth was the burst of money printing that caused a mini-boom in the US stock markets and caused some measures of economic activity to pick up in the US.  Following that burst of money creation the money supply grew at a steady 7.3% rate.  In March and May of 2012 (earlier this year) U.S. M2 growth collapsed to 0%.  We were extremely concerned at that time a crash would result.  The Fed resumed money supply growth at about 8% since then.  If the 2 months of 0% growth are averaged in with the past 6 months of 8%, then the average growth for the past 8 months has been around 6%, which is actually less than the 7.3% for the 7 preceding months.  This means we are actually in a period of slower money growth.  As a result the US markets and economy are showing signs of weakness with the exception of the housing sector.

US Banks have almost $1.5 Trillion (yes, Trillion) of excess reserves.  The Federal Reserve has an unlimited capacity to create new money and they are adding $40 Billion per month from the QE3 program with no end announced.  The US money supply could accelerate at any moment if US banks accelerate lending or if the Fed accelerates printing.  If this happens, it will quickly show up in the Money Supply and US Banking Reserve statistics published by the Fed.

Our interpretation of all this information is that US markets are unlikely to grow in the near future, but circumstances could change quickly.  The best investing advice we have for these circumstances is to avoid all bonds as interest rates will eventually rise when price inflation accelerates.  The 8% rate of money printing following the past printing will eventually cause price inflation to accelerate, and that will cause bond prices to fall.  Avoid US stock markets for now and consider investing part of your portfolio in hedges against price inflation.

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