Since making a new low on May 17th, the markets have moved appreciably higher. In less than a month, the Nasdaq gained 8.5%, while the S&P500 and Dow each netted nearly 6%. This fast run led us to note one week ago that the markets were “rapidly approaching – but not quite at yet – an overbought short term condition.”
Since then, the markets have achieved that dubious distinction of being dramatically overbought state. That suggests to us that some selling and/or sideways action would be healthy, allowing the market to work off its “condition.” That i’s what must happen when markets get ahead of themselves.
To work off this overbought condition, we would like like expect to see a few more days of orderly selling – or simply sideways action. This could will bring equities down to a level that may be too tempting for buyers to ignore. We like that selling hasnot begat more selling. What few “disasters” we’ haveve seen have been admirably contained to individual names, and are not painting entire sectors red. We continue to be relatively constructive on the markets, and are willing to be patient in looking for more advantageous entry points.
But we keep coming back to the issue of Money Supply (see chart nearby). As mentioned previously, the Federal Reserve has been pumping cash into the system at a fantastic rate. Indeed, the Money Supply increase for May was the highest injection of liquidity the Fed has put into the system since the post 9/11 period.
That grabs our attention. Recall the two most recent periods of high Money Supply increases: Pre-Y2K, and post 9/11. The Markets greeted each of these M2 spike intervals like an injection of nitrous oxide into a racing engine.: They took off, soaring further and faster than anyone expected. The recent fuel injection is a significant increase: It has led to some speculation (amongst the cynics) that the Fed – the ultimate insiders – are bracing us for ‘something bad.’
We find this argument unconvincing. The Fed has shown little in the way of prescience (i.e., Y2K) and gets the same intel – for better or worse – as does the White House, Pentagon, and USAG. We continue to advocate patience in waiting for appropriate levels: Dow 10,200-300, Nasdaq 1950-60, and SPX 1115-25 are where investors youcan start scaling into the markets adding as they pull back further.
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