For Monday May 13, 2013, We Recommend Against Investing

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Investment Recommendations:

Avoid US stock markets right now.  Price inflation hedges remain good long-term investments.  Continue to avoid all bond investments.

 Technical Comments:

The S&P 500 advanced 0.43% on Friday with volume below Thursday and lighter than the 30 day moving average.  Friday was a light-volume up-day.  This past week saw daily market data consistent with market growth, and that makes three weeks in a row of technical strength following a fully formed growth pattern.  The only technical weakness in the pattern is that the strong volume has been only slightly above average.  If the S&P 500 declines around 45 points on Monday (-2.8%) our automated forecast would likely change to an uncertain trend.

Subjective Comments:

After a fully formed growth pattern and three weeks of daily patterns in the market data that are consistent with growth, it is difficult to recommend to our readers they ignore our technical pattern recognition software and avoid investing right now.  Our subjective opinion had been moving towards making an investment recommendation, but the US M2 money supply growth has fallen off dramatically in the past two weeks.  This is very concerning from the perspective of Austrian Business Cycle Theory (ABCT).  To fully explain why we are still hesitant and are recommending staying out of US stock markets right now, we will show the graphs of the money supply growth and our residual control chart analysis.  The commentary that follows is very similar to our prior post, but it has been augmented with the graphs to help explain our concerns.

US-M2-NSA-Growth-9MAY2013

ABCT explains that an accelerated money supply growth rate must occur to initiate a bubble-boom, and then the growth must continue to accelerate to sustain the bubble.  If the growth rate remains constant or slows, the bubble will and must end.  The graph above shows US M2 with our straight-line curve fits and the associated annualized growth rates.  What is important to note is that over the past 20 months the M2 annualized growth has been an average of 7.3% (red dashed line).  This represents constant growth, not accelerated growth, and that’s why ABCT predicts the current bubble is at risk of ending.  In the past 13 months the M2 rate has not been a steady 7.3%.  It has been swinging back and forth recently.  The 14% growth rate has spurred recent market growth, but the -39% three months ago has created the risk.  While M2 then grew at 13% for 3 months, it has just collapsed again over the past 2 weeks (shown by the -50% region at the far right of the graph).  The graph below zooms in on the past 7 months and shows the residual control chart.

US-M2-NSA-Growth-9MAY2013-Residuals

The residual control chart shows the 14% growth and 13% growth regions as horizontal lines.  The variability above and below the constant growth rate falls within the control limits except at the -39% growth 3 months ago, and again with the most recent data point falling below the lower control limit.  (See the red dot at the bottom right of the chart.)  We wrote yesterday about the 4-week sub-cycle in the M2 series.  This can be seen on the control chart where often every 4th week has a decline.  The week before last had a large decline, but it occurred as expected with the 4 week sub-cycle and still within the control limits.  We thought the most recent data point would be near the prior week because this sometimes happens at quarter points.  Instead the trend continued strongly down.  When we saw the 20-month constant M2 growth is combined with this recent drop in the M2 growth, we changed our bullish opinion back to a neutral stance, and that’s why we are not recommending investing for growth right now.

While we are concerned US markets might not continue to grow, we are also not entirely convinced they are bound to decline just yet.  If M2 were to resume strong growth the current bubble-boom could be extended.  The US banking reserves published last week showed some reason to think M2 might accelerate in the near future.  The graphs below show US Banking Required Reserves shooting up, and this means US banks made more loans which will accelerate M2.  At the same time US Banking Excess Reserves declined, which is consistent with growing Required Reserves.  The graph below also shows the Monetary Base, also called the Fed’s balance sheet.  Notice it also declined.  The decline in the monetary base explains part of the drop in excess reserves and is curious given the Fed’s policy of printing $85 Billion of new money every month.

US Banking Reserves plus M0 NSA 9MAY2013

It is possible the recent changes in the Money Supply and Monetary Base could be blips and growth could resume.  It could also be any resumed growth will not be enough.  After the market closed on Friday an article was published by the Wall Street Journal by Jon Hilsenrath.  ZeroHedge.com provides the key parts of this article with commentary if you don’t have a subscription to the WSJ.  The article discusses a potential exit strategy for the Fed to slow or stop the $85 Billion of monthly money printing.  The publication of the article after the market closed was on purpose.  Market participants would likely have reacted by selling.  By publishing late on Friday perhaps some participants will not notice the article, or perhaps they will have time to consider the impact before trading resumes on Monday.  When the Fed does slow or stop printing the market will decline because almost all the major participants understand the
impact money printing from the Fed has on the market, even if they are not aware of ABCT.  Fed watchers know Jon Hilsenrath has very good sources at the Fed, so his articles about monetary policy are considered very credible.

The next few days and weeks will be important to watch for clues to the future direction of US markets, the US economy and price inflation.  The US market and economy is very large and does not react instantaneously to changes in the money supply.  Given the current conditions and recent history, we think it is too risky to invest based on guesses of what the money supply will do.  Continued patience and vigilance are called for right now.

Welcome to our new readers!  We’re glad you’re here and hope you’ll stick around a long time.  Have a great weekend!

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