For Wednesday June 5, 2013, We Recommend Against Investing


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 declined 0.55% on Tuesday with the day’s volume not yet published at the time of this posting.  If the S&P 500 declines about 3 points on Wednesday our automated market forecast is likely to change to an uncertain trend.

Subjective Comments:

US markets were down on Tuesday, including the Dow Jones index.  After 20 consecutive weeks of an up-day for the Dow on Tuesday, the Dow moved down.  Stock traders look for correlations, any correlation they can find, and then trade assuming the past will predict the future.  The 20 up-day Tuesdays is one such correlation.  There are many others that appear more sophisticated, but the increased sophistication does not make them more reliable.  Our automated pattern recognition software looks for patterns that have historically occurred at market turning points, and when such patterns are identified our system creates new signals.  This could be considered the same type of correlation process.  We contend there are two different types of correlations.  One is the coincidental that randomly appears like the 20 consecutive Tuesdays.  The other type of market correlations are patterns that can be tied to human action.  When people who trade and invest in the market buy and sell, the daily market data is the result.  When lots of people all start doing the same thing, the market data patterns show detectable patterns.  We think these types of technical analysis are useful but not perfect, and that’s why we provide commentary in addition to the output of our proprietary algorithms.

Sound technical analysis is a part of forecasting the stock market.  The other and more important piece is a solid understanding of Austrian Business Cycle Theory (ABCT).  Using ABCT to interpret changes in the money supply provides a sound theory for prediction.  ABCT acknowledges the complexity of predicting human action and does not attempt to precisely identify how quickly the economy and asset bubbles will form and pop in reaction to money supply changes.  Even so, ABCT is properly deducted from economic laws and axioms.  It forms the proper theory for explaining cause and effect of how the business cycle of boom and bust happens.  Combining this knowledge with our technical analysis is what provides the basis of our subjective investment recommendations.  If you have the time we encourage you to learn more about Austrian Economics and Austrian Business Cycle Theory.

In the past US banks have typically lent the maximum amount allowable by regulations and excess reserves were very small.  From January 1975 to September 2008 US banking excess reserves fluctuated but never exceeded $9.2 Billion Dollars except following the September 2001 attacks on the World Trade Center and Pentagon.  For two weeks following 9/11/01 US banking excess reserves jumped to $38 Billion, but by the beginning of October 2001 there were back down to $2.7 Billion.  Data from the Federal Reserve on excess reserves can be calculated from the Fed’s H3, Table 4 data.  This data shows excess reserves were very small from 1975 to September 2008, but what about before 1975?  Murray Rothbard, an American economist of the Austrian School wrote multiple books on the topic of banking and US banking history.  In The Mystery of Banking, (published in 1983) on page 134 he described the typical practice of US banks regarding required reserves.  He wrote

…the only remaining limitation on credit inflation is the legal or customary minimum reserve ratio a bank keeps of total reserves/total deposits.  In the United States since the Civil War, these minimal fractions are legal reserve requirements.  In all except the most unusual times, the banks… keep “fully loaned up,” that is, they [lend] the maximum permissible amount on top of their total reserves.  (Emphasis in original)

From the Fed’s data and Rothbard’s writing it is clear US banks did not keep large amounts of excess reserves except for the most unusual of circumstances.  Since September 2008 excess reserves have risen to their current level of almost $1.9 Trillion Dollars!  This is an astounding break from the historical record, and it happened because the Federal Reserve began paying interest to US banks for excess reserves on 10/3/2008.  The Emergency Economic Stabilization Act of 2008, Section 128, allowed the Fed to pay interest on excess reserves.  This provides quite the incentive for US banks to accumulate excess reserves.

The situation with excess reserves today has no historical comparison.  Prior to 2008 the Fed’s money printing was done to manipulate the Feds Fund rate via buying and selling bonds on the open market.  The Fed lost the ability to drive interest rates lower using this traditional tool, so they have embarked on Quantitative Easing.  QE money printing has wound up in the banks and has accumulated as excess reserves.  This has mitigated price inflation, but it has put US banks in a position to decide when and if they want to lend these funds.  Talk of the Fed slowing and stopping the printing presses has been in the news lately with speculation QE could slow during the summer and halt altogether by the end of 2013.  Will this cause a crash?  In the past it almost surely would lead to a slowing of the money supply growth and cause a market crash as described by ABCT.  That could happen.  Another possible alternative is what US banks will do.

If the Fed slows the printing presses, interest rates will start to rise.  In fact the yields on US Treasury bonds have been increasing and so have interest rates on home mortgages.  At some point if interest rates go high enough, US banks could decide to move money in excess reserves and lend to get a higher rate of return.  If that happens, the fractional reserve money multiplier would kick in and the US M2 money supply would begin to accelerate the money supply growth.  If growth is fast enough, then bank lending could delay a market crash for a while, even years.  If banks do not lend and M2 growth remains low like it currently is, then a market crash will happen much sooner just as ABCT describes.

This has been a long post.  We’ve taken the time to provide these details in order to explain why we keep saying the future from here is uncertain.  When the Fed does something these days it makes headlines.  If US Banks accelerate lending, we seriously doubt any news source would report on it.  Austrian Economic and ABCT provide the proper foundation for interpreting what will happen as a result of changes in the money supply.  Every Thursday the Fed publishes money supply data (H6, Table 7).  We don’t know what will happen, but we know by tracking the money supply and using our technical analysis we will be able to give our readers enough advance notice to avoid serious losses from the next market crash.  We hope this information helps explains why we’re currently cautious regarding what will happen, and why we’re very confident we’ll be able to report on changes in time for our readers to invest accordingly.

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