M2 - Money Supply

There's been some discussions about the "collapse" in the rate of growth of M3, the money supply. I question both the timing and accuracy of these speculations since M3 is no longer being used by the Federal Reserve. From the Federal Reserve press release on the cancellation of M3 data:

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. ...

M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits. Source

Below is an Excel chart made from the Federal Reserve data. The magenta line is the straight line continuous growth trend which appears curved on an arithmetic scaled chart. It is apparent that in the latter part of 2008 the rate of growth in M2 increased rapidly as liquidity was injected into the system because of the financial crisis. Over the last 18 months the rate of growth slowed towards the more normal rate. The data point on April 19th was the low spot and M2 has turned higher since then.

Turnaround Confirmed

The low in in. While the recent negative reading in the 10% Index of the MCO suggests the markets will need another retest of the low, it does not mean we have to revisit the low price zone, nor does it have to happen right away. A degree of caution remains prudent, as the markets are skittish and responding to negative news badly.

With the MCO approaching the zero line and the SPX approaching the 200 day average from below we could see a slight hesitation on Friday before the three day weekend.

Never the less, the zig-zag in the MCO is being confirmed by all the other market internals and the possibility for a very strong rally is very high. Adding to the technical picture, the sentiment indicators are wildly negative.

As of 5/26/2010, AAII members are:
Bullish: 29.82%
Neutral: 19.30%
Bearish: 50.88% <-- blood in the streets type fear.

At the Crossroads

Maybe today's reversal was the end of the decline. The McClellan Oscillator has moved in a small range for the last two days and this type of behavior usually precedes a strong move, one way or the other. That was what occurred today, unfortunately we started from a huge down gap before rallying. Whatever, change your underwear and get ready for some upside action, assuming of course that we're through crashing.

I still feel there is the need to complete a retest of the current low zone with the 10% component staying above the lower limit of -500, something which could occur within a week or get dragged out for a month. Once that is complete, the upward rally should continue to new recovery highs and confirm the bull market status. (i.e. higher lows and higher highs on the intermediate term)

Oops

We're in crash mode here. I'd expect a bounce on Friday because of the oversold condition, end of week shortcovering and option expiration. Other than that, I doubt the markets can generate a turn before late Monday or Tuesday.

Added @10:00 PM: While things look very scarey at the moment I suspect that the current declining phase is about over. The MCO is so oversold that we could see a strong rally tomorrow but this may depend more on the option market than anything else.
We can be sure that across the waters, bankers and politicians will be working over the weekend to find the right shade of lipstick. The markets are setup for a crash or a rally, I suspect they want the latter.

I've now added someother technical indicators for historical reference.

Set up for a bounce

Unfortunately the MCO 10% component brokedown indicating the current low zone requires a retest.

While it's possible we are at the start of a waterfall meltdown, I suspect this isn't the case. The MCO is extremely stretched out on the downside and this usually results in a vigorous bounce.

The breakdown in the 10% Index is more worrisome because this condition generally results in a retest of the lows before the trend upward is reestablished. What may lie ahead for the next 4-6 months is a range bound market until the fundamentals become clearer.

MCO Update

It turns out that the big spike down may have been the result of a 75,000 sale of EMini contracts by Waddell & Reed [AP story] Whatever, it completed the setup for the formation of a nice low at current market levels. It's allowable for a the markets to decline a bit more in the next few days but any excess of bullish sentiment has been erased and prices on individual issues seem to be firming. Never say never, but as long as the markets don't collapse from todays levels I believe a reversal is in process. A nasty close to the downside would invalidate my opinion but only to the degree that more time would be needed to complete the bottoming process.

The McClellan Oscillator and its Components
Click to enlarge


Breadth and Sentiment Indicators
Click to enlarge

EU show of support to stem Euro crisis.

GEE WIZ -- With the MCO lower than it was in March 2009 we conveniently have a show of force. Expect the market to rally on Monday. The markets will eventually try to retest last weeks decline but NOT the spike low.
From Bloomberg News:
"EU Crafts $962 Billion Show of Force to Halt Crisis"

By James G. Neuger and Meera Louis

May 10 (Bloomberg) -- European policy makers unveiled an unprecedented loan package worth nearly $1 trillion and a program of securities purchases as they spearheaded a drive to stop a sovereign-debt crisis that threatened to shatter confidence in the euro. Jolted into action by last week’s slide in the currency to a 14-month low and soaring bond yields in Portugal and Spain, governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators.

The ECB will also embark on “very significant operations,” European Union Economic and Monetary Commissioner Olli Rehn told reporters in Brussels after the 14-hour meeting. “The ECB has taken a decision to intervene in the secondary markets of government securities.”

Under pressure from the U.S. and Asia to stabilize markets, the European governments gambled that the show of financial force would prevent a sovereign-debt crisis and muffle speculation that the 11-year-old euro might break apart.

Europe’s failure to contain Greece’s fiscal crisis triggered a 4.1 percent drop in the euro last week, the biggest weekly decline since the aftermath of Lehman Brothers Holdings Inc.’s collapse. It prompted President Barack Obama to call German Chancellor Angela Merkel and French President Nicolas Sarkozy yesterday to urge “resolute steps” in Europe to prevent the crisis from cascading around the world.

Under the loan package, euro-area governments pledged to make 440 billion euros available, with 60 billion euros more from the EU’s budget and as much as 250 billion euros from the International Monetary Fund, said Spanish Economy Minister Elena Salgado.

“We are placing considerable sums in the interests of stability in Europe,” Salgado told reporters after chairing the meeting.

MCO Update

The market is in the midst of a mini panic in response to uncertainties over sovereign debt, primarily Greece. As of todays close the McClellan oscillator is very oversold and I would expect a bounce between tomorrow and Tuesday. Because of the seriousness of the decline it's likely the markets will need a week or two to rebuild confidence.

The McClellan Oscillator and its Components
Click to enlarge