For Monday November 11, 2013, We Recommend Against Investing


Investment Recommendations:

Avoid US markets and watch closely to see what trend develops.  Cash positions (including currency) and price inflation hedges are still recommended.  There is too much uncertainty in US markets right now to make an investment recommendation, but things are turning bearish again after having been bullish for most of October.

Technical Comments:

The S&P 500 advanced 1.34% on Friday, regaining Thursday’s entire decline.  Friday’s volume was below Thursday but above the 30 day moving average.  We consider this a light-volume up-day even though volume was above average.  The reason we consider Thursday’s decline more significant that Friday’s recovery is based on the volume.  Our technical analysis has not identified a fully formed pattern of predictive value, but both a bearish and bullish pattern are developing.  It is common for both types of patterns to begin development at market turning points.  The S&P 500 would have to decline about 56 points (-3.2%) on Monday for the stop loss trigger to change our automated forecast to an uncertain trend.

Subjective Comments:

We received a wonderful email from a reader with the following suggestion:

I really think you should just put a buy on the overall total stock market thru year end and be done with it.  M1 and M2 will have little to no impact on stocks from here on out during Q4.

That second sentence got us thinking.  Do we agree that the money supply (M1 and M2) will have little to no impact on stocks for the remainder of the year?  The end of the year is just under 8 weeks away, so this is a short horizon for making a prediction.

We use two forecasting process.  One is our automated analysis of the daily market data, and the other is our subjective interpretation of money supply growth using Austrian Business Cycle Theory (ABCT).  Both of these techniques attempt to identify market turning points, and then to forecast the direction the market will go following the turning point.  Our forecasting process does not estimate how long a trend will persist.  For this reason we will not depart from our standard processes and attempt to predict what the market will do for a given period of time.

We have carefully reviewed the past 7 years of market data and money supply growth rates along with our technical forecasting signals.  There are times in the past where money supply growth has been strong and the market has been booming, and there is a clear lag time between changes in the money growth rates and when the market reacts.  This lag is explained by ABCT, but the time between money growth changes and market reaction is not consistent nor is it predictable.  This is because the lag comes from human action and the decisions of millions of individuals, and they will never react the same way as they did before.

This brings us to our current circumstances with money supply growth and the market.  Prior to October this year, US M2 had been growing at a slower rate compared to Q4 2012 and the total 2012 growth.  When the money supply has been growing and fueling a market boom there will be a crash when the money supply fails to accelerate its growth or if growth slows.  For all of 2013 the market boom has been fueled by 2012’s money supply growth and sporadic zigzag growth in 2013.  The average 2013 growth through the zigs and zags has been low until October when growth shot up from fractional reserve lending.  We think the bubble-boom that has been in progress is getting near its top because the US money supply growth has been slow for the first 9 months of 2013.  The 25% annualized growth for most of October has been the wildcard.  If M2 continues to grow in excess of 20% we think the ABCT market crash will be delayed and the bubble-boom will continue.  If the 25% growth seen in October collapses back to something below 10%, then we’re not confident the bubble-boom can continue.

Our current circumstances are very similar to the summer months of 2011.  While history will never repeat itself exactly, we see this period of comparison as indicative of what can happen and why we’re not ready to jump into the market.  Here are the facts and sequence of events from summer 2011:

  • Week Ending 6/13/11: S&P500 @ 1271, US M2 growth @ 6.7% annualized for the prior 42 weeks and our automated forecast predicted a market decline
  • Week Ending 7/18/11: S&P500 @ 1345, US M2 growth @ 24% annualized for the prior 4 weeks and our automated forecast predicted market growth

Notice the similarities to October 2013.  Our forecast predicted a market decline, but instead the market went up.  US M2 had been growing for 6% annualized for 22 weeks but only 3% for 2013 YTD, and then in October US M2 accelerated to 25% annualized growth.  Just like July 2011, a few weeks after predicting a decline, our automated forecast changed to predict growth.  The key similarity is the prediction of decline at almost the exact time M2 growth accelerated from a 6% range to a 25% range.

Let’s continue the comparison.  Mid-July 2011 saw our forecast predict growth and M2 had accelerated to 24% annualized.  Let’s look at where the market was one month later in Mid-August 2011:

  • Week Ending 8/15/11: S&P500 @ 1124, a 16% market drop in just four weeks.  US M2 growth remained at 24% annualized for only 7 weeks.  Starting 8/15/11 the M2 growth rate fell to 7.3% annualized, very close to the 6.7% rate that had persisted for 42 weeks as of 6/11/11, just 2 months earlier.

In the summer of 2011 the 7 week M2 growth of 24% annualized was not enough to prevent a 16% market correction after a long period of M2 growth at 6.7%.  The bubble-boom that started to pop in 2011 was the end of the boom created by the Fed’s initial Quantitative Easing following the crash in late 2008.  The 7 weeks of 24% M2 growth was followed by a slightly higher 7.3% M2 growth, so this started another boom after the 16% S&P 500 decline.

In Early November 2013 (now) we have had 4 weeks of 25% annualized M2 growth.  This follows an average (zigzag period) growth of around 3% for the prior 37 weeks.  The slow growth for 37 weeks in 2013 follows stronger growth (9.3%) in 2012, so the circumstances for an ABCT crash are present.  The comparison to the summer of 2011 is very similar, but we must not conclude the similarities mean a 16% market crash is imminent.  This is where human action comes into play.  People will not react the same way now as they did in the summer of 2011.  Too many other things have changed.  However, we should also not conclude US markets will resume a bubble-boom for a long period of time just because we’ve seen 4 weeks of 25% annualized M2 growth.  The truth is we don’t know what will happen next.

Many thanks for the email!  It forced us to carefully look at the past few years for comparisons to see if we’re being too cautious.  We hope the details we’ve provided better explain why we continue to recommend against investing and are not ready to make a subjective market prediction.

For our readers who would like to see a graphical representation of the discussion above, the graph below is provided.