For Monday July 8, 2013, We Recommend Against Investing


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 Friday by 1% with volume above Wednesday but far below the 30 day moving average.  Despite the low volume day our algorithms classified Friday as a strong-volume up-day.  In the past week there was both a strong-volume up-day (Friday) and a strong-volume down-day (Tuesday).  At market turning points it is common for both types of days to appear.  A turning point can be a bottom turning up, a top turning down, or a plateau in a trend that resumes its prior direction.  There have been a few more strong-volume down-days than strong-volume up-days in the past 2 months, but there have also been enough light-volume days in between to prevent the formation of a fully formed pattern.  Based on just our technical analysis it appears the market is at a turning point, but it is not clear if we are at a top that will turn down, or a bull market plateau that will resume an upward trend.  Should the S&P 500 decline about 22 points on Monday (-1.4%) our automated forecast could change to an uncertain trend.

Subjective Comments:

If all we considered was our technical analysis from our automated algorithms, we would be uncertain if US markets would resume an upward trend or decline.  Fortunately we can combine our technical forecasting with the trends in the US money supply and provide a more complete picture using Austrian Business Cycle Theory (ABCT).  Usually the Federal Reserve publishes weekly money supply updates every Thursday, but this week the data was delayed by the US Independence Holiday.  The weekly US M2 (not seasonally adjusted) money supply data has been published and we continue to see very weak growth in the money supply.  Using ABCT it is our very strong subjective opinion that the US economy and stock markets are heading for a crash.  In 2012 the money supply grew from $9.7 Trillion to $10.6 Trillion, an increase of 9.3%.  The most recent US M2 data shows the money supply at $10.5 Trillion as of 6/24/13, and this is essentially unchanged since the beginning of the year.  An annual growth of 9.3% followed by 0% growth for 6 months is setting up the classic crash conditions described by ABCT.

It is astounding to consider that at $85 Billion per month, the Fed has printed almost $600 Billion Dollars in the past 7 months, yet the US M2 money supply has not grown at all.  This can only be explained by the lack of net lending by US banks.  Under the fractional reserve banking system when loans are paid off, the money supply shrinks.  When fractional reserve loans are made, the money supply grows.  Since the Fed has printed $600 Billion Dollars in the past 7 months, US banks have allowed the same amount of loans to be paid off without creating new loans to replace them.  US banks are sitting on top of $1.9 Trillion Dollars of excess reserves they could loan, but they are not doing so.  We can only speculate as to the reasons banks are not lending.  It is likely people and businesses are unwilling to lend borrow even at historically low interest rates.  It could also be the new banking regulations from the 2010 Dodd-Frank law encouraging banks to accumulate excess reserves in anticipation of stricter capital reserve requirements.  It could also be that US banks are content to earn 0.25% risk-free interest on those excess reserves since the Fed now pays interest on these reserves as of October 2008.  Whatever the reason, the fact remains US banks are clearly not lending very fast and this has caused the money supply growth rate to collapse to 0% for the past 6 months.  If this continues US markets will crash.  ABCT explains that once the money supply has been expanded, the bubble-boom that occurs must eventually pop.  There is no avoiding the crash.  The timing is very difficult to predict.  Our pattern recognition software has still not identified a predictive pattern, so we are still uncertain when the crash will occur.  We can confidently say the crash is getting closer.

Even though the Fed has not slowed its purchase of US Treasury bonds, the prices of bonds are falling as yields increase.  If the Fed “tapers” back its purchases, bond prices will fall from the removal of demand.  If the Fed continues to print money, bond prices will fall from the increasing concerns regarding price inflation.  We are in a massive bond bubble.  Bond prices have started to fall, but they will fall much further.  Avoid all bonds.  If you own any bond investments, sell them.  Do not wait.  Get out of bonds now.

As price inflation in the US persists and potentially gets worse it is likely the Fed could taper back on its money printing and perhaps even raise interest rates.  If they do this slowly it will not halt inflation.  The mild interest rate increase under Fed Chairman G. William Miller (3/8/78 – 8/6/79) was not enough to stop the very serious price inflation of the late 70’s.  It took increasing interest rates to about 3 percentage points above the inflation rate by Fed Chairman Paul Volcker to kill price inflation in the early 1980’s.  Based on this history it is clear what would have to be done to stop price inflation, but it is not at all clear if the Fed has learned this lesson or will have the courage to act decisively.  When money is printed the result is price inflation along with a bubble boom.  There is no avoiding the subsequent crash, although the crash can take one of two forms.  Either the money printing ends and prices crash, which is what the US has experienced in the past century, or the crash is a hyperinflation.  Price inflation can spiral out of control into hyperinflation only when the population becomes convinced prices will not stop climbing and people start buying whatever they can before their cash loses purchasing power.  This is the sad history of paper money throughout history.  How much longer the US can continue down this path is unclear, but history and economic law dictate our current course cannot persist without serious economic consequences.

We continue to recommend holding and accumulating cash in order to take advantage of the crash we see coming in the near future.  There will be an opportunity to invest in funds that increase in value when US markets crash.  Having a portion of your investments available for this is why we recommend cash.  Otherwise avoid US markets right now.  Price inflation hedges are likely to be very volatile in the near and intermediate term, but over the long term they will likely do very well given the Fed’s tendency to print money.  Hold your price inflation hedges.   Our best guess of when US markets could crash is anywhere between now and the end of October.  There is a study that shows historically September is the most common month for the start of a banking crisis (hat tip

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