For Monday December 10, 2012, We Recommend Against Investing

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Technical Comment:

The S&P 500 advanced 0.3% on Friday with volume below Thursday and lighter than the 30 day moving average.  If the S&P 500 were to decline about 13 points on Monday (-0.9%) our forecast would likely change to an uncertain trend.

Subjective Comment:

Our automated pattern recognition software continues to forecast growth based on the absence of the stop loss trigger.  We have not seen a fully developed predictive pattern in quite a while.  This leaves us to develop a subjective investment opinion based on the growth of the money supply, economic indicators and interpretation using Austrian Business Cycle Theory.

After the US M2 money supply update on 12/6/12, we noted the growth rate continues to accelerate, reaching an annualized growth of 8.5% over the past half year.  Upon a more detailed review of this data and considering that QE3 began on September 13th, 2012, we decided to look at the annualized M2 growth differently.  Instead of aggregating a single straight line through the past half year, we looked at the growth prior to QE3 and since QE3 began.  This approach shows a 7.2% annualized growth for the 3 months prior to QE3, and 9.6% since the inception of QE3.  This is show on the graph below:

US Money Supply 12-9-2012

Coincidently (or causality), at about the same time QE3 began we saw an increase in Required Reserves of US Banks.  The timing is more difficult to see in the biweekly data series, but it has become clear Required Reserves are now increasing whereas for over half a year prior to QE3 US banks had been holding Required Reserves constant.   Banks are required to hold 10% of deposits as Required Reserves within the US fractional reserve banking system.  When these Excess Reserves grow it means in total, US banks are increasing the net loans outstanding.  Via the fractional reserve money multiplier, expanding loans results in a growth of the money supply.  The major two contributors to money supply growth are the Fed’s Quantitative Easing (aka Money Printing) and fractional reserve lending by US banks.  With QE3 now in progress for the past 3 months and an accelerating rate of bank lending, US M2 is not growing at 9.6% over the past 3 months.

We assume the US M2 growth will continue and is likely to accelerate.  The Fed’s “Operation Twist” is about to end, and there is speculation when the Fed meets Tuesday and Wednesday this week (12/11 & 12/12) they will announce a continuation of the monthly purchases that has been ongoing under Operation Twist, but without the offsetting sterilization.  This means the monthly money printing from the Fed could double within the next week or two.  This would be a monthly printing rate greater than what occurred during QE1 and QE2.  Combined with the accelerated bank lending seen over the past 3+ months and this is why we think the 9.6% annualized growth of US M2 will accelerate.

Austrian Business Cycle Theory explains what happens when money supply growth accelerates.  A bubble-boom happens with overinvestment (mal-investment) in long-term, capital intensive industries such as home building and manufacturing.  This happens from the abnormally low interest rates.  This distortion of the economies capital structure can stimulate hiring and result in lower unemployment.  Price inflation usually results as well, and we think this is very likely as the offsetting factors that would suppress price inflation are not present in our opinion.  The Official price inflation, as measured by the Bureau of Labor Statistic’s Consumer Price Index will likely remain in the 2% to 3% range, but this number is highly unreliable.  If the CPI were still calculated as it were in 1980, it would be near 10% right now, as confirmed by  When a bubble-boom happens from accelerated money printing, all prices accelerate including stock prices.  We think US M2 growth will reach double digits in January and the US economy and stock markets will grow.  In the long run this will be destructive when the bubble eventually pops, which it must.  How long the boom will last depends on the Fed’s monetary policies and US bank lending.  It could last for months or for years; there is no way to predict duration.

In order to grow your investments faster than price inflation, and to grow fast enough to overcome capital gains taxes (which will likely increase starting in January), leveraged investing is necessary.  For the rest of December US markets are unpredictable.  It is time to consider accumulating positions in leveraged index funds that grow with US markets.  Consider investing on any market weakness for the remainder of December.  If you prefer to invest large amounts in a single trade, consider waiting until late December or early January.  If you are more aggressive, begin accumulating a position now.  Continue to avoid all bonds.  Avoid Eurozone and Chinese stocks as well.  Price Inflation hedges remain a good long-term investment.  If you have been accumulating price inflation hedges, hold them.  We are going to wait until after the Fed announces any changes to its monetary policy later this week before making a change to our official investment recommendation.  Watch for this Thursday evening / Friday morning.


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