For Friday, November 16, 2012, We Recommend Against Investing


Technical Comment:

The S&P 500 declined 0.16% Thursday with volume below Wednesday but above the 30 day moving average.  The S&P 500 would have to advance about 1.2% on Friday to reverse the stop-loss trigger in our automated process in order to change our forecast back to growth.

Subjective Comment:

The market declined again on Thursday with strong volume, but our pattern detection software did not classify Thursday as a strong-volume down-day.  The S&P 500 is now down 5.25% since the election last week.  It is rare that our automated process identifies a pattern that predicts a decline, but such a pattern is forming.  We doubt this pattern will fully develop given the accelerating rate of the US money supply growth.

The Federal Reserve published the weekly US M2 money supply statistics and the bi-weekly US Banking Reserves data.  QE3 is starting to show the accelerating growth of the US M2 money supply.  Over the past 28 weeks the straight-line growth of US M2 has risen to 8.2% annualized.  This annualized growth has an average increase of $16 Billion Dollars per week.  What was very interesting in the M2 data was the actual weekly increase from 10/29 to 11/5 was $153 Billion, almost 10x the average increase!  We’ve analyzed the residual control chart of the weekly data (not seasonally adjusted), and no out-of-control conditions are present.  However, the most recent data (11/5) showed a spike upwards.  It is the largest weekly spike in the past 6 months and was not far from the upper control limit.  There is also a distinctive cyclical pattern and visually there is a growing trend over the past 14 weeks.  All of this means US M2 is accelerating.  The growth rate is going to have to get much higher than the current 8.2% in order to stimulate an overall economic bubble-boom and in turn lift stock prices.  Currently the QE3 purchases of Mortgage Backed Securities are stimulating the housing market.  It is very likely US M2 will accelerate going forward.

Looking at US banking reserves it appears some of the QE3 money is being held in excess reserves, and some might in fact be increasing required reserves.  (An increase in required reserves indicates US banks are creating new loans faster than old loans are maturing.)  The banking reserves data is notoriously noisy and the small changes in the most recent data are not definitive.  The subtle increases are consistent with the slowly accelerating US M2 money supply growth.

We think the growth of the US M2 money supply will accelerate, and when it does there will be an opportunity to invest in index funds that track US stock markets.  So far the growth rate is not strong enough to encourage us to make a recommendation to invest.  We still see a lot of uncertainty for the remainder of 2012, and the daily market data this week has been horrible with multiple strong-volume down-days.  Continue to invest in price inflation hedges because it is going to continue and eventually get worse.  Avoid all bonds and be ready to invest in US markets soon.