For Friday January 10, 2014, We Recommend Investing in US Markets

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Investment Recommendations:

It is time to invest in US stock markets.  Price inflation hedges should be held for the long term and remain a good idea as we expect price inflation to accelerate in 2014.  Avoid all bonds.

Technical Comments:

The S&P 500 advanced 0.03% on Thursday with volume below Wednesday but above the 30-day moving average.  The index was barely changed and our pattern recognition software classified Thursday a light-volume down-day.  No predictive patterns are present in the daily market data.  If the S&P 500 were to decline about 19 points on Friday (-1.0%) our market forecast could change to an uncertain trend.

Subjective Comments:

Some very interesting data for the US Money Supply (M2, Not Seasonally Adjusted) and US Banking Reserves (Not Seasonally Adjusted) was published today.  Starting with the money supply, M2 continues to grow and now has a straight-line curve fit rate of 9.1% over the past 11 weeks.  This continues the trend of an accelerating growth rate for M2, but what is really very interesting is the absence of the common 4-week sub-cycle.  M2 (nsa) exhibits a common dip every 4th week, with 2 subsequent dips every quarter.  This pattern disappears at times when growth trends are changing.  It was due to appear last week, but we did not think too much of its absence because of recent changes since October.  However it did not appear again this past week for data ending on 12/30/13.  The absence of the expected dip implies M2 might be accelerating and next week could see a jump.  This could also be year-end adjustments, so it would be imprudent to infer too much at this point.  Still, it is interesting and different.

The M0 monetary base (AKA the Fed’s Balance Sheet) went DOWN $83 Billion in the past month!  This is very interesting because the Fed had been printing $85 Billion per month during 2013 and has announced they intend to slow the printing press to $75 Billion per month in 2014.  So in the last month of 2013 they still printed $85 Billion, yet their balance sheet shrank by $83 Billion.  2 weeks ago there was a minor pause in the growth which happens from time to time, but this updated showed a huge drop.  The most likely explanation we can think of is a reverse repo operation where the Fed first printed $85 Billion in December, and then drained $168 Billion after the start of the year.  This needs to be watched carefully.  Another data series is US Banking Excess Reserves which dropped by a suspiciously similar amount of $98.6 Billion.  The slightly larger drop of excess reserves implies the M0 drop was indeed a reverse repo and the rest of the drop was used by banks to originate new loans.  This needs to be watched very closely as it indicates a behavior change by the Fed.

Required Reserves continue to grow which means banks are lending and appear to be accelerating their new loan originations faster than old loans are maturing.  It is still unclear if this is going to be a sustained trend, but it appears likely.  If this continues, US bank lending will overwhelm any effort by the Fed to control price inflation.  The only true lever the Fed could pull is to increase the required reserve ratio, but the Fed appears to have forgotten they have that tool or they are too afraid to use it.  The Fed prefers to try and tweak the economy and they likely consider changing the reserve ratio a sledge hammer approach.  What we think the Fed fails to realize is their “tweaking” removed $168 Billion from an ocean of $2.4 Trillion of excess reserves.  Excess Reserves went down from $2.44 Trillion a month ago to $2.34 Trillion.  The Fed’s attempt to restrain lending will not work if Banks want to lend.  We still think price inflation will accelerate beyond the Fed’s wildest expectations.  The Fed is right to be frightened.  They have no idea what they are doing.  Price inflation hedges remain a very good idea, but avoid TIPS and all bonds as the serious inflation we expect to occur will drive bond prices down and erode the purchasing power of the minor gains if you hold them to maturity.  Other professional investors are concerned about price inflation as well.

We still think investing in US markets is the right decision for now.  If the money supply growth rate changes we could change our opinion.  Unless and until that happens, we recommend leverage investing to help grow your wealth faster than the rate of price inflation.  Leveraged investing has risks and you should be aware of them.  A regulatory body (FINRA) today issued warnings about some of the risks involved with leveraged ETFs.  We see leveraged ETFs as a good tool if properly used and suggest you consider them for investing in US markets, but do read about them and make sure you understand the risks.  We want you to make informed decisions.

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