For Tuesday June 25, 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 1.2% on Monday with volume below Friday but above the 30 day moving average.  Our software process classified Monday as a light-volume down-day even though volume was strongly above average.  Our technical analysis has identified the beginning formation of patterns that predict further downward motion for US markets, but the formation is not complete and it is not a common occurrence for these patterns to complete their full development.  Still, there are more strong-volume down-days occurring with very few strong-volume up-days.  This is the type of daily patterns consistent with declining markets.  The S&P 500 would have to advance about 1% on Tuesday to return our forecast to a growth trend.

Subjective Comments:

Even if US markets advance enough Tuesday to flip our automated forecast back to a growth trend, we will still subjectively advise against investing for growth in US stocks right now.  The business cycle in the US is at a turning point and the most likely outcome from here is a crash in the near future.  Austrian Business Cycle Theory (ABCT) correctly explains why economies and markets boom and crash in cycles.  The root cause is the expansion of the money supply, specifically the rate of change in the money supply.  US M2 money supply was growing at an annualized rate of 14% at the end of 2012.  6 months later US M2 growth has zigzagged sideways and has only grown about 2% (annualized).  The growing money supply was bidding up asset prices (stocks) and keeping interest rates down.  Even though the Federal Reserve has been printing $85 Billion per month, which has been just over a Half Trillion Dollars in the past half year, the US money supply is effectively unchanged!  If you’re wondering how is it possible to print a hall trillion dollars and not have the money supply increase, it is because bank lending also grows the money supply.  The supply of money is both currency and bank credits.  Loans from banks create credit which grows the money supply.  You can spend your bank money (debit cards) the same as cash, so they’re all part of the money supply.  When loans are paid the process is reversed and bank credit is decreased.  This means the next bank lending has been much less than originations of new loans in order to offset the printing by the Fed.

The dramatic drop in the money supply growth rate is why US markets are no longer growing and are at risk of a crash.  We are guessing a crash could occur in July (next month) or perhaps in October, or anywhere in between.  Circumstances now are similar to mid-1929, just a few months before the famous US market crash in October 1929 that was the start of the Great Depression.  Murray Rothbard provides a superb explanation of ABCT (also called the Austrian theory of the trade cycle) in his study of the Great Depression in his book America’s Great Depression.  The following quotes from this book show the similarities to our current situation when compared to the summer of 1929:

…the money supply… rose by $1.51 billion in the first half of 1928, but this was a relatively moderate rise.  This was a rise of 4.4 percent per annum… – Pages 160

The “money supply increased by almost $1.9 billon” in the last half of 1928. This was 5.4% per annum.  At the time the increase from 4.4% to 5.4% was sufficient to cause stocks “to skyrocket, increasing by 20 percent from July to December.” – Page 161

The inflation of the 1920s was actually over by the end of 1928.  The total money supply on December 31, 1928 was $73 billion.  On June 29, 1929, it was $73.26 billion, a rise of only 0.7 percent per annum.  Thus, the monetary inflation was virtually completed by the end of 1928.  From that time onward, the money supply remained level, rising only negligibly.  And therefore, from that time onward, a depression to adjust the economy was inevitable.  Since few Americans were familiar with the “Austrian” theory of the trade cycle, few realized what was going to happen.

A great economy does not react instantaneously to change.  Time, therefore, had to elapse before the end of [credit expansion] could reveal the widespread malinvestments in the economy…  The turning point occurred about July…  The stock market had been the most buoyant of all the markets – this in conformity with the theory that the boom generates particular overexpansion in the capital goods industries.  For the stock market is the market in the prices of titles to capital…  the stock market took several months after July to awaken to the realities of the downturn in business activity.  But the awakening was inevitable, and in October the stock market crash made everyone realize that depression had truly arrived. – Pages 162-163

Recent talk from the Fed of “tapering”, which means a slowing of the rate of printing, has caused the recent market decline.  Traders are selling both bonds and stocks.  Usually bonds and stock prices move in different directions, but now both are declining at the same time.  There will be 7 speeches by Fed officials this week, all of whom will attempt to calm the markets.  This talk could cause some increasing prices as was the case on Monday afternoon.  US markets had been down nearly 2% for the day but recovered a bit when one official suggested the Fed would keep printing.  Assurances and Fed Printing will not matter if US banks accumulate all the newly printed money as excess reserves instead of creating new loans.  This is what has been happening for the past 6 months.  Excess reserves in US banks are just shy of $2 Trillion Dollars.

Avoid all stocks and bonds right now.  If you choose to short either of these markets, be sure to do additional research.  Price inflation hedges will most likely not advance in price for a while and could likely decline.  Over the very long term price inflation hedges will move higher as the Fed continues to print, so only invest in price inflation hedges if you can hold for the long term.  We suggest having some cash available to short US stock markets in the near future.  We suspect as the crash approaches our automated forecasting system will identify opportunities to invest in funds that grow when US markets decline.

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