Our long term bullishness on equities is predicated on increasing money supply and relatively low borrowing costs.  As of yesterday’s report by the Federal Reserve, M2 contracted materially on a non-seasonally adjusted basis for the month of May.  This could be a repeat of Summer 2008 with a major interim top in equities if M2 continues to shrink or even stays flat.  Accordingly, we are adjusting our long term forecast from bullish to neutral, awaiting more data over the next month.  A key difference between this summer and the previous is the substantial increase in the supply of Treasuries and funding needs of the US government.  Without the Fed printing money to purchase Treasuries, supply will force Treasuries lower and yields higher, as oversold as they may already be.   Shrinking M2 has a double whammy effect on stocks because the amount of money available for borrowing falls and interest rates rise.  This rally was kicked off with a precipitous rise in money available for borrowing over several months as well as low interest rates/borrowing costs.  With less money available for borrowing and now higher interest rates, we expect this to weigh heavily on equities.  This is not a short term signal, but one that will play out over the next month or two.  Accordingly, we can still see a short covering bounce in Treasuries and new equities highs, though we believe they will be reversed dramatically, unless there is a material increase in M2 or lowering of interest rates.

Click for larger image.

1:42 pm EDT: What we mentioned in the prior post could be explained by problems at NYSE order routing that halted trading in 240 companies.  See here for story.

Tick volatility is a measure of the volatility of the Tick symbol that represents the number of net issues on the NYSE that are upticking or downticking. A high reading means that stocks are simultaneously going higher then lower intra-minute and a low meaning means they’re roughly all in line with each other (or doing nothing).  Tick volatility normally follows the same daily pattern, where it starts out elevated, then drifts lower through lunch, then becomes extremely high into the close.  So far, it has followed that pattern today, except that it has drift to as low as 61, when normally it doesn’t get below 200.  When Tick volatility rises after a sustained trend or consolidation, it often signals a trend reversal in price or a break from consolidation.  As we have never observed Tick volatility readings this low before, with data going back one year (and it could be a data issue, though we don’t think so), we can only throw out as a possibility that a rise in Tick volatility will give rise to a more dramatic price movement.  However, we believe the warning is warranted.

Readers can track Tick volatility by using the standard volatility indicator available on most platforms using a 14 period lookback on a 1 minute Tick chart.

We’re consolidating below the daily gap/pivot area, so are still bearish, but would lower stops to breakeven on any remaining shorts from the 938-939 level.

Market internals are moderately weak, and as the ES is below the daily gap/pivot area of 938.25 to 940.75, we are bearish.  935.00 (VWAP and today’s point of control) to 935.75 (50% off overnight high) is a sell area as is 938.75.   Target is 930.00, then 926.00.   Above the pivot/gap area, we should see short covering.

The financial indexes we’ve been watching are down, but not in immediate danger of breaking critical support.

Click here.