For Friday February 07, 2014, We Recommend Against Equity Investing


Investment Recommendations:

We are changed our subjective recommendation.  Sell US equity positions and hold cash.  Price inflation hedges should be held or accumulated for the long term as price inflation is starting to accelerate.  Avoid all bonds, including the new MyRA bonds announced recently.

Technical Comments:

The S&P 500 advanced 1.24% on Thursday with volume above the 30-day moving average but below Wednesday, making Thursday a light-volume up-day.  The above-average volume trend continues.  Our pattern detection software has not identified a pattern that predicts markets will decline, but there have been two 50-50 patterns recently.  This means currently the odds of growth or decline are equal.  Our pattern detection software has also identified so many strong-volume down-days recently that growth patterns are now being suppressed and will not form as part of our technical analysis.  In other words, our technical analysis is highly unlikely to produce a growth pattern anytime soon.

The large advance in the S&P 500 index was sufficient to reverse our stop-loss trigger and as such our automated market forecast has returned to a growth trend.  If the S&P 500 were to decline about 13 to 14 points on Friday (-0.8%) our stop-loss algorithm could trigger again and flip our forecast back to an uncertain trend.

Subjective Comments:

Please ignore our automated forecast.  The reversal of the stop-loss algorithm is not something to use as the sole deciding factor to invest in the US stock markets.  Our technical analysis has identified two 50-50 patterns and many more strong-volume down-days than up-days.  With growth patterns now being suppressed, all of the indicators in our technical analysis point to uncertainty.  Maintain a risk-off position relative to US markets.  We are not ready to recommend a short position, but we are moving in that direction.

The US M2 money supply and banking reserve data was published on Thursday and we’ve looked at it carefully.  For the past 3 weeks in a row US M2 (not seasonally adjusted) has been declining.  With this third point the residual control chart we use has identified an out-of-control condition.  This means the decline has finally reached enough magnitude that we can declare there has been a change in the growth trend of the money supply.  For the 14 weeks from mid-October to the first week of January US M2 grew at an annualized 12% rate.  That 12% rate ended 3 weeks ago.  The rate of decline for the past 3 weeks was enough to wipe out all of the accelerated growth that occurred for the last 3 months of 2013.  M2 itself is now at the level it was in early December.

It is difficult to say if the money supply will continue to decline or if the current 3-week plunge will stop.  However, Austrian Business Cycle Theory (ABCT) is on full display right now.  For the first 9 months of 2013 US M2 grew at around 3% annualized going into October.  We speculated then the US economy and stock market was nearing a crash as a result of the slower growth in 2013 versus 2012.  In mid-October the money supply growth rate accelerated suddenly to 12% annualized where it stayed until 3 weeks ago.  The bubble-boom in US markets continued through the 4th quarter, but economic weakness still has become visible in recently reported Q4 results.  This is precisely what ABCT predicts.

Here is what is very unsettling about the current circumstances.  ABCT explains how bubble-booms are created by accelerated money supply growth, and it goes on to explain that a crash will occur when the rate of growth slows.  In the past 3 weeks the money supply has actually fallen, which is a negative growth rate.  This is a very big change compared to annualized 12% growth.  This is happening at the same time as weak economic data from Q4 is available along with weakness in emerging markets.  The Chinese market reopens tomorrow following the Chinese New Year, and it has had some weakness recently.  The Fed has slowed the printing presses and the Head of the Fed has just changed.  We find it very interesting that US markets have become volatile recently and have begun a decline through January.  When all of this is combined with our technical indicators point to weakness, we see every reason to suspect US markets are going to decline from here.  This is a clear change in our subjective opinion from earlier in January.  An opportunity to short US markets could develop in the very near future.  In the meantime continue to avoid all bonds and hold on to your price inflation hedges.

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