For Friday December 13, 2013, We Recommend Against Investing

Investment Recommendations:

Avoid US markets and watch closely to see what trend develops.  Cash positions (including some currency outside of bank accounts) and price inflation hedges are still recommended.  There is too much uncertainty in US markets right now to make an investment recommendation, although it is probably safe to hold any currently owned equities for a few weeks.

Technical Comments:

The S&P 500 declined 0.38% Thursday with volume below Wednesday but above the 30-day moving average.  Our pattern recognition software classified Thursday a light-volume down-day.  A predictive pattern has still not formed, but the basis for a predictive pattern remains in place and was not disturbed by the light-volume down-day.  However, the decline was enough to trigger our stop loss algorithm and has changed our automated market forecast to an uncertain trend.  If the S&P 500 were to advance about 4 points on Friday (+0.2%) our forecast could flip back to a growth trend.  Our market forecast is susceptible to frequent changes between an uncertain trend and a growth trend right now.

Subjective Comments:

If the US M2 (not seasonally adjusted) money supply were growing like crazy we would ignore today’s stop loss trigger.  Having analyzed the M2 growth rate with the weekly update published by the Fed, we remain cautious about the US stock market right now.  Our caution is diminishing a bit and we’re becoming bullish in our subjective outlook.  Our advice remains to stay out of the market and continue watching to see what trend develops, and we think the money supply growth trends are becoming more supportive of a continued bubble-boom.  However, we would need to see stronger M2 growth before recommending investing.  Here is what we’re seeing in the money supply and banking reserve statistics:

  • Since mid-October the straight line curve fit has shifted to a growth rate of 4.2% annualized, but this is only over the past 7 weeks.
  • In the first 2 weeks of October M2 grew at 26% annualized.  This puts the past 9 weeks at an annualized growth of 9.1%.
  • For the first 9 months of 2013 the average M2 growth was just under 3%.
  • In 2012 the annual growth rate was 9.3%, but could be considered around 8% to 9% depending on methods of calculation.

We think these are the key growth percentages: 2012 was about 9%, followed by 3% growth for 9 months and is now around 9% again over the past 9 weeks.

Austrian Business Cycle Theory explains that an accelerating growth rate is needed to sustain a bubble-boom.  We saw the 3% growth for the first 9 months of 2013 as a deceleration versus 2012 and have been very worried all year about a crash.  We even guessed the crash could happen by the end of October if M2 did not accelerate.  In October M2 growth did accelerate and is now around 9% again.  9% growth after 9 months of 3% growth can be considered acceleration.  This is why we are turning a little bullish.  It is also why we’ve said a serious market decline is unlikely through the end of December and likely through the end of January.

US banking required reserves are a good proxy measure for bank lending.  During the first quarter of 2013 required reserves were falling.  In April required reserves recovered quickly and then remained virtually unchanged until 7 weeks ago.  Since the start of November required reserves have been growing at an annualized rate of 57%.  This means US banks have accelerated the rate of new loan originations, and the rate of new loans being created is stronger than the rate of old loans maturing.

The M2 jump in October preceded the start of required reserve growth.  We think US banks began moving funds around from different accounts (with different reserve requirements) in October to prepare for accelerated lending in November.  M2 does not seem to have responded to the growth in required reserves, but if required reserves continue to grow from bank lending, then M2 growth will accelerate.

The acceleration in required reserves growth is supported by a reduction in the growth of excess reserves.  From mid-June to mid-September excess reserves were growing at an annualized rate of 67% as a result of the $85 Billion a month of money printing, also called Quantitative Easing.  Since mid-September QE money printing has continued at the same rate, but the annualized growth of excess reserves has slowed to 43%.  This small deceleration was difficult to spot but is now obvious.  In the past 12 weeks banks have been accumulating a bit less of the QE money printing as excess reserves.  This paints a consistent picture and suggests the US money supply growth could be about to seriously accelerate.

The recent series of strong-volume down-days could be a buying opportunity.  If the Fed announces no taper next week we would expect a jump in US markets since taper expectations appear to have been somewhat priced in.  If the Fed does taper, markets will probably react by going down since any taper is surely not fully priced in.  What is very important to remember is that the Fed’s QE money printing, and any taper, does not matter right now.  Banks have over $2.4 Trillion of excess reserves and could lend money for a long time even if the Fed were to stop printing altogether.  The Fed is concerned about excess reserves and is looking for ways to prevent them from creating too much price inflation.  The “Reverse Repo” program is one way to try and control excess reserves.  It is unlikely the Fed will move quickly enough to stop an outbreak of money supply growth and the consequent price inflation.

We will be watching the market closely, especially any reaction to the Fed’s taper decision early next week.  We want to see if more strong-volume down-days accumulate or not, and we will be very interested in the money supply update Thursday next week.  For all the reasons listed above we are turning bullish on US equities and could change our subjective recommendation by the end of the month.