For Friday February 22, 2013, We Recommend Against Investing

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Technical Comment:

The S&P 500 declined 0.6% on Thursday with volume slightly above Wednesday and above the 30 day moving average.  This was another strong-volume down-day, making the third such day in the past four trading sessions.  This is very worrisome for the current bull market.  The rapid accumulation of strong-volume down-days is the type of daily data that precedes a downturn in the market.  A fully formed predictive pattern typical of historic patterns has not developed, but the formation has clearly begun.  Our automatic forecast remains at an uncertain trend for the second day in a row.  The S&P 500 would have to advance about 10 points on Friday (+0.7%) to change our forecast back to a growth trend.

Subjective Comment:

In our following discussion we will explain why we are changing our investment recommendation to Risk Off.  This change in our subjective assessment means we are telling our readers to sell their equity positions and hold cash instead.  We continue to recommend avoiding all bonds and holding price inflation hedges for the long term.  Now is probably a good time to consider accumulation of additional price inflation hedges, especially if your portfolio is absent of assets that grow in price when price inflation accelerates.  However, our advice to avoid all bonds includes TIPS bonds too.  Do not buy TIPS bonds as a hedge against inflation.

Something has happened to spook US banks.  They have decelerated the rate of originating new loans and this has caused the US M2 (not seasonally adjusted) money supply growth to collapse.  US M2 growth from early September through mid-January had been 14% annualized, which was about $28 Billion per week.  Based on a straight line curve fit.  From January 7th to January 28th (3 weeks), US M2 dropped $238 Billion.  Annualized that was a -39% growth rate.  In the past 4 weeks US M2 has ticked up at an annualized 4.3%.  If just the past 3 weeks are considered, US M2 has ticked up an annualized 14%.  The US M2 data series is much too noisy to determine a trend in 3 to 4 weeks.  To summarize, it appears what had been a 14% growth rate for about 4 months was followed by a sharp drop and then resumption in growth.  The resumed growth rate could be anywhere from 4% to 14%, and there’s no indication if the growth rate has stabilized.  If the past 5 months are used then the annualized growth rate would be 7.6% which is not much different from the 6.7% growth prior to 5 months ago.  Austrian Business Cycle Theory (ABCT) explains why an accelerating growth rate is necessary to initiate and sustain a bubble-boom.  We just had 3 months of a doubling of the US M2 growth rate, and not that doubling has been wiped out.

We had speculated 2 weeks ago the US M2 drop could have been bad data.  The speculation was based on inconsistent data when comparing US M2 to the Fed Funds rate and US banking reserves.  The Federal Reserve is still printing $85 Billion per month and pumping it into the economy, so we were not sure the large drop in US M2 was real.  Now we see the Fed Funds rate creeping up ever so slightly.  More significantly in the formation of our opinion is that US Banking Required Reserves dropped $12 Billion in the two weeks from February 6th to 20th.  This decline has a negative impact on the Fractional Reserve Money Multiplier, which means it is consistent with the $238 Billion US M2 drop.  Excess Reserves continue to climb and are now at $1.615 Trillion Dollars.  In the past 2 months almost all of the Fed’s QE4 money printing has wound up in Excess Reserves!  This means instead of the QE4 money actually winding up in the economy it’s just sitting in the bank, literally.  Why US Banks have stopped lending as fast as they had been and have decided to accumulate excess reserves is anyone’s guess.  What matters is that this is in fact what they are doing, and the consequences are described by ABCT.  If US M2 does not resume very rapid growth, then US markets are going to correct.  The bubble-boom will not continue if US M2 growth is in the 4% range.  Even at the 14% range from here it is likely markets will pause before resuming growth.

It could be the political drama from Washington D.C. (sequester cuts), or the Eurozone debt crisis, or the crashing Chinese economy.  It could be the recent comments from various members of the Federal Open Market Committee, or it could be the various earning reports and economic data released recently.  It could be something else entirely.  Whatever the reason, US Banks have decided to accumulate the QE4 money printing as excess reserves and scale way back on originating new loans.  The result has been a change in the US M2 growth rate.  If there is any good news here, it is the identification of this change in the trend.  When we combine this information with our automated forecast having changed from the stop loss trigger and multiple strong-volume down-days in a short period, we conclude it is time to react.  We could be reacting too soon, but we feel it is better to liquidate market positions and be wrong than to allow our portfolio value to decline further.  If we are wrong, there will be plenty of opportunity to get back into the market.  We are not forecasting a market decline and we are absolutely not yet recommending shorting the US market.  Our advice is to sell long positions and hold cash while waiting to see what happens next.  Place your sell orders now.