For Friday November 01, 2013, We Recommend Against Investing

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Investment Recommendations:

Avoid US markets and watching closely to see if a trend develops.  Cash positions (including currency) and price inflation hedges are still recommended.  Subjectively we hold a neutral opinion that has been turning bullish recently, but there is too much uncertainty in US markets right now.

Technical Comments:

The S&P 500 declined 0.38% on Thursday with volume above Wednesday and higher than the 30 day moving average.  Thursday and Wednesday were consecutive strong-volume down-days following consecutive strong-volume up-days on Monday and Tuesday.  This has not yet resulted in a predictive pattern so our forecast remains for market growth.  If strong-volume down-days continue to accumulate then our forecast could change.  If the S&P 500 were to decline about 45 points on Friday (-2.5%) our stop loss algorithm would likely change our forecast to an uncertain trend.

Subjective Comments:

We have closely analyzed the US M2 (not seasonally adjusted) money supply and the banking reserves data.  The money supply is indeed growing at a faster rate over the past few weeks.  Two weeks ago we noted the disruption in the 4-week sub-cycle of the M2 (NSA) money supply.  Last week the accelerated M2 growth continued to disrupt the cycle and with the most recent data now published (for the week ending 10/21/13) the M2 money supply has created a high-out-of-control condition on the residual control chart we use to identify changes in M2 trends.  This confirms the M2 has accelerated its growth rate.  The banking reserves data is less clear.  It appears the excess reserves might be slowing in their growth, but it is not obvious.  We would expect to see required reserves growing to support our hypothesis that the recent M2 acceleration is from an increased rate of fractional reserve lending by banks.  Required reserves is a very noisy data series so trends take a while to become obvious, but so far there is no obvious change in the required reserve trend.  Every other week required reserves alternate high then low, and this pattern continued.  If required reserves were to go up two weeks from now, that would confirm accelerated bank lending.  It is unfortunate that it will take two weeks to get the next update on banking reserves.  We are not quoting M2 growth rates this week because there has been only 3 data points in the new trend, and that’s much too soon to estimate the growth with a linear curve fit.

Of all the money supply data published this week, the acceleration of US M2 is the most significant.  It is not clear from banking reserves if the new M2 growth rate will be sustained or not, so this is why we are cautious about recommending investing.  If there had not been 2 consecutive strong-volume down-days, and if banking reserves had been consistent with the accelerated M2, then we would be recommending investing for growth.  We are very concerned the recent M2 acceleration could end as abruptly as it began 3 weeks ago.  The recent acceleration comes a few weeks following the quarter close.  The acceleration could simply be a lack of maturing loans concentrated after the quarter close, which is possible given the historic quarterly sales cycles of banks.  We have decided to watch for 1 to 2 more weeks before changing our investment advice.  For now we continue to recommend against investing in US markets.  Put part of your investable funds into price inflation hedges because the growth in the money supply will eventually lead to accelerating price inflation.  We still suggest having part of your portfolio in cash, some in a brokerage account and some in currency.  We think a new market trend will eventually present itself and having some cash in your brokerage account will allow you to take advantage when it becomes clear.

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