Why The Next 2 Weeks Could Determine If A New Bear Market Is Imminent

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Includes: EUO, UUP
by: Austrolib

Summary

The August 24th, 2015 market crash followed a prolonged period of stalled monetary expansion.

Money supply tends to drop sharply after tax day, and we'll see how much it dropped this year in two weeks' time.

If the drop is close to 2% or more as it was in 2015 stock could get dicey.

Geopolitical events could exacerbate the situation, including a Le Pen victory in France, or a flare-up on the Korean peninsula.

Who remembers Black Monday, August 24, 2015? The Dow fell over 1,000 points and the Nasdaq over 400 in one of the worst days for investors since 1986. As for the VIX, it was so frenetic that it crashed, literally, and could not be calculated for the first few minutes of that trading day. When the VIX finally went back online, it briefly broke 50.

I'm not predicting that this will happen again in 2017, but the next two weeks will help determine if it does. I don't mean North Korea, or the contentious French elections, or any global geopolitical hot spots that may flare up over the next two weeks. I'm referring to tax day, which yes, already happened, but for which the monetary affects will be reported by the Federal Reserve only over the next two weeks.

There is a big drop in the dollar supply that tends to happen in the last week of April, a drop that can be seen in the Federal Reserve's weekly Money Stock Measures report, or the H.6. Last year, the monetary fall in the last week of April (reported on a 10-day delay) accounted for 1.2% of the total M2 money supply from April 18th to the 25th. This drop was not intense compared to other years, and was fully recovered by early July as weekly M2 reached a new high on July 4. No crash ensued. By contrast, 2015's M2 drop in the last week of April was a full 2% in two weeks and M2 didn't regain its highs until August 31st.

By then it was too late. There was not enough new money in the system to support the market structure so a crash happened.

Looking back at 2008, the same thing happened, but worse. M2 also dropped a full 2% from April 14th to the 28th and didn't break to new highs until late September. We can argue chicken and egg all day about cause and effect here, whether the money supply caused the Great Recession or the Great Recession caused a stagnating M2, but whatever you believe, there does tend to be a buffer of several weeks between M2 growth bottoming out and any significant bear market.

What does this have to do with tax day? Given that these 1-2% week-over-week drops in M2 almost always occur in the same week of the year, it seems to have something to do with a bunch of money moving out of people's checking and savings accounts and heading to the IRS, though this is speculation. Regardless, it happens every year around this time, and we can count on it happening again. If the drop is close to 2% this year or more (check the 1-week M2 average on the H.6 release to see), it's time to be careful, and here's where the geopolitical factor does come into play.

If this year's drop is around 2% or more, the situation could be heavily exacerbated by any number of undesirable events. One could be a runoff between anti EU Marine Le Pen and the hard left Jean-Luc Mélenchon in France, and this we will find out on April 23. A runoff between these two could actually mean a Le Pen victory. While more mainstream candidates like Macron or Fillon would almost certainly beat Le Pen in a runoff, Mélenchon may not. And if Le Pen wins, the European Union, along with the euro, could quickly fall apart. Leaving the EU is on the top of Le Pen's agenda.

There is also the possibility of a flare-up in North Korea, which by itself would not cause a bear market but could worsen existing tight monetary conditions. Previous administrations have been able to keep the situation on the Korean peninsula out of the headlines, but the Trump Administration has kept its nuclear arsenal in the limelight, with an armada headed over there as a show of force.

Again though, aside from a possible Le Pen victory and EU breakup, North Korea is a side issue. The country has no importance to the global economy. What's most important right now is how much M2 will drop over the next two weeks. It's not the news but the reaction to the news that's important for traders, and that reaction depends on the monetary situation. Meaning, whether there will be a knee-jerk sell-off in response to any geopolitical instability followed by a quick recovery, or a sell-off followed by a longer term bear market, depends first on how much M2 falls, second by how fast it recovers (July would be bullish, late August/September bearish), and only third by political disturbances.

Bottom Line

As for what traders should do, here's a rough timeline-based outline. First, if there's a runoff between Mélenchon and Le Pen come Monday morning market open, consider going long the dollar (NYSEARCA:UUP) or short the euro (NYSEARCA:EUO). Second, come Thursday May 4th and we know how deep this year's M2 plunge is, anything more than 1.8% and traders may want to start taking money off the table and selling into strength. If M2 doesn't recover by mid-August, only then is it time to duck and cover.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EUO over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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