For Friday October 18, 2013, We Recommend Against Investing

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Investment Recommendations:

Circumstances have changed!  We are rescinding our forecast for a market decline and recommending avoiding any investments in US stock markets.

Technical Comments:

The S&P 500 advanced 0.67% to a record high close on Thursday with volume just below Wednesday but above the 30 day moving average.  This is technically a light-volume up-day, but the above average volume on an up-day is significant for the current trends.  US markets have advanced 3.25% in the past 2 weeks since we forecasted a market decline.  This advance has been enough for our automated forecast to trigger the short stop-loss.  Our forecast is now for market growth and exiting short positions is necessary.  It will still be a few more days before a new stop-loss baseline is available for the growth forecast.

Subjective Comments:

It is time to acknowledge US markets have not declined as we have expected nor as our forecast has indicated.  If you have short positions we recommend selling immediately and regret our system has produced a false decline signal.  Our analytical process is correct more often than wrong, but of course it is not perfect.  It is worth noting that historically when our system produces a decline forecast it can be a short time (days to a couple of months) until another decline forecast is produced.  When our decline forecasts cluster like that historically, the second decline forecast is more likely correct.

MONEY SUPPLY

Weekly US M2 (not seasonally adjusted) money supply and biweekly banking reserve data was published Thursday.  Two weeks ago we noted a jump in required reserves and a slowdown in excess reserve growth.  We speculated this might be noise.  The most recent data shows all the Quantitative Easing money ($85 Billion per month) accumulating in excess reserves again.  However, the blip two weeks ago does not appear to have been noise but instead an actual acceleration in bank lending that only lasted 2 weeks.  This is probably tied to the government shutdown.  We speculate short term loans were taken by people affected by the brief income disruption.  What is extremely interesting is a corresponding uptick in M2 itself.  The most recent M2 data is almost 2 weeks old, so it corresponds with the uptick in required reserves from 2 weeks ago.  The uptick in M2 is within the control limits on the residual control chart (see figure below), so it is probably just noise.  However when the 4-week sub-cycle pattern is evaluated visually it becomes apparent the M2 uptick grew above its typical pattern.  If we are correct in speculating lending accelerated for just 2 weeks as implied by the resumption of excess reserve growth, then US M2 will not accelerate next week.  Some people likely think the increase in the debt ceiling combined with the reopening of the government is a good thing, and they may seek business loans.  It’s impossible to guess what US M2 will do, so that’s why it must be tracked weekly.  The graph below shows the US M2 data with our straight-line curve fitting.  Superimposed is the residual control chart associated with the straight-line growth for the past 5+ months.

US-M2-NSA-Growth-17OCT2013

The key US M2 growth rates are:

  • 2012 US M2 annual growth: 9.2% (dotted line above)
  • 2013 Year-to-Date annualized growth: 3.6% (not on image above)
  • Annualized straight line growth for the past 23 weeks: 6.3% (inside box on image above)

Austrian Business Cycle Theory (ABCT) explains that an accelerated money supply growth rate will produce a bubble-boom that will crash when the money growth slows.  After 9.2% growth last year the current growth rate has slowed, so a crash must eventually occur.  If US M2 accelerates the coming crash could be delayed.  If US M2 accelerates sufficiently a bubble boom could resume.  We have been speculating the weak M2 growth for such a long time has weakened the US economy and stock markets.  This is why we’ve been expecting an ABCT crash anytime.  It appears M2 growth has been enough to delay the crash we know will eventually occur.  There is another possibility.  In January and again in April the US M2 moved above the straight-line trend just before declining strongly toward the end of the month following the end of the calendar quarter.  We are approaching the end of October, which is the end of the month following the previous calendar close, and US M2 just moved above the trend line by breaking the 4-week sub-cycle.  With required reserves still unchanged since the beginning of the year and excess reserves growing strongly again, we might see another zigzag decline in M2 over the next few weeks.  Remember it is impossible to predict what M2 will do as the Fed’s money printing and fractional reserve lending both influence the M2 growth rate.  We are speculating here.

CONCLUSION

The daily S&P 500 data along with money supply trends must be watch closely from here for the next investment opportunity.  ABCT explains the economic cause and effect relationship between money supply growth rates and the boom-bust cycle.  Based on these facts a market crash will occur if US M2 growth rates remain below 9.2% annualized.  If rates remain weak a crash will come, and we expect our technical forecast will again produce a decline signal under such circumstances.  If US M2 growth rates are about to surge then it is possible US markets could climb some more before crashing.  In the next few weeks it should become obvious if US markets will decline or climb.  Until then we are recommending avoiding any investments in US stock markets.  Instead maintain cash positions and consider investments in price inflation hedges.  The ongoing growth of the US money supply might not be enough to sustain a bubble boom, but it will cause price inflation.  Regarding cash positions, consider having a considerable portion in currency outside the US banking system as capital controls are quietly being implemented.