For Tuesday July 2, 2013, We Recommend Against Investing

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Investment Recommendations:

Avoid US stock markets right now.  Continue to avoid all bond investments. Price inflation hedges remain good long-term investments, but only invest in price inflation hedges amounts that you can leave invested for a very long time.

 Technical Comments:

The S&P 500 advanced 0.54% on Monday with volume below Friday and lighter than the 30 day moving average.  Monday was a light-volume up-day.  The S&P 500 had been up well over 1% but the index pulled back near the end of the day as volume increased and closed at about half of the peek for the day.  The pattern of strong-volume down-days and weak-volume up-days continues to dominate the daily market data.  There have been occasional strong-volume up-days, but not as many strong-volume down-days in the past 6 weeks.  The frequency of the strong-volume days remains too spread out temporally for a formation of a predictive pattern, but the overall pattern is more consistent with a market in decline.  Should the S&P 500 decline about 22 points on Tuesday (-1.4%) our stop loss algorithm could trigger and change our forecast to an uncertain trend.

Subjective Comments:

Continue to ignore our automated forecast.  It is changing back and forth between “growth” and “uncertain” based on our stop loss algorithm which is susceptible to large market volatility during sideways movement as is common at market turning points.  We think the market is at a turning point now.  Most likely US markets will move down from here, although there is a small change for growth if US banks accelerate lending.  That is a big “if” and there are few indications this will happen.

We frequently discuss Austrian Business Cycle Theory (ABCT) and how the Federal Reserve’s money printing causes bubble-booms and subsequent busts in the stock market and economy.  By the nature of our daily posting we provide a superficial reference to ABCT because it is a detailed and rich body of knowledge, too much to cover in a daily market update.  We encourage you to learn more at sites like the Ludwig von Mises Institute.  Today an article published by Frank Shostak discussed conventional (and wrong) economic thinking used by the Fed to justify monetary stimulus (money printing).  He then explains from an Austrian perspective what actually happens in response to the Fed’s money printing.  Here are relevant excerpts:

…the entire [mainstream economic] framework of thinking regarding the existence of some kind of a growth path that the Fed supposedly could navigate the economy onto is erroneous…

Whenever the central bank raises the pace of monetary pumping in order to bring the economy onto [what it thinks is] a self-sustaining growth path, it in fact sets the stage for various
non-productive bubble activities. The increase in these activities, which is hailed as economic prosperity, sets in motion the diversion of real wealth from wealth generators toward bubble activities. It weakens the process of wealth generation.

Whenever the Fed curbs its monetary pumping this weakens the diversion of real wealth towards bubble activities and threatens their existence. Note that bubble activities cannot support themselves without the monetary pumping that diverts real wealth from wealth generators. This leads to an economic bust.

A part of ABCT important to understand right now is what happens when money printing stops or slows down.  The prior money printing caused interest rates to go down, which in turn caused more loans to occur than otherwise would have happened.  This is simple supply and demand.  When the price of a loan (interest rate) drops, more is consumed than would have been at a higher price.  Many businesses and entrepreneurs borrowed at cheap rates and started projects.  Since money printing leads to price inflation, the costs to these businesses and entrepreneurs will be higher than they expected.  As they experience higher costs they will either have to abandon their project or take out another loan to try and make a smaller profit or suffer less than a total loss.  The slower money printing by the Fed means the new loans will be more expensive.  Some will be able to afford the more expensive loans, but many will not.  When projects are abandoned there will be losses.  Some losses will result in the inability to pay back the loan.  This is the sequence of events that occurs as the bubble-boom reaches its peak and pops.  If banks to no accelerate lending at a pace to grow the money supply faster than it was previously growing, the interest rates to continue the in-progress business projects will be too high.  This is the situation we face in the US as money growth has slowed in the past half year.  It takes time for the changes in the money supply growth rate to impact the market and economy.  There are many complex factors involved in our advanced economy.  The decline in US M2 money supply growth from 14% annualized to less than 3% for the past 6 months is a big decline and a long time.  If these circumstances persist, we guess a market crash could occur anytime between now and the end of October.

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