I used to take a small sailboat out onto the Great South Bay in Long Island during the summer. It was fun to zip along the warm, protected waters. A good wind would take us miles away to other communities where you could pull the boat up onto a beach and have lunch. On the way back home, there was always the risk of an afternoon drop in the wind. The first few times it happened, we would jig the sails this way and that, pump the rudder back and forth and even break out the paddles in a vain attempt to recapture the glorious, almost effortless movement we had enjoyed for most of the day. When a little puff came along, we would scramble to get the boat and sails positioned, often just in time to feel it fade away.

Later, as the summer progressed, we got smarter. We would pack some extra drinks, snacks and cushions. When the wind died, we put our feet over the side and waited for the wind to pick up again in the late afternoon. It always did. The sails would fill, the boat would heel over and we would be back in the docks in no time.

The financial markets today remind me of my youthful sailing adventures and the experience helps put this week’s frantic market commentary into perspective. Despite a 5% pop in the S&P500 last week, we are still becalmed and no amount of fluffing the sails or pumping the rudder is going to bring back the easy times of the Great Moderation (1982-2000) just yet. The Global Financial System is suffering from a lack of wind: the markets (financial, property, good and services, employment, global trade) are finding their new levels. The American Consumer, the great engine of global export growth, is rediscovering the concept of savings. The exporting powerhouses of Asia and Europe are slowly coming to terms with the market shifts and even the value of the US dollars that they collected during the boom years. This will all take a few years to sort out.

What signs should we look for?

One basic reason for the range bound markets is the lack fresh money coming into the financial system. Much of the money that was “printed” by the FED’s quantitative easing program has stayed very close to Federal Reserve vaults because money center banks have mostly arbitraged the near zero overnight funds against short term Treasuries. Not much of this “high powered money” is finding its way into the real economy.

So, the first sign to look for is a return to M3 growth (currently running at negative 4% on an annual basis). M3 for the US dollar is no longer released by the Federal Reserve but this week we have a short review of a site (ShadowStats.com) that continues to track the broadest money supply series. Check in once a month to see how things are progressing.

M3 Chart

Source: Shadow Government Statistics

What is the Fund King System saying?

For the US only investor, the system continues to rank Treasuries (TLT), Investment Grade Corporate Bonds (LQD), Gold (GLD) and Utilities (XLU) at the top of the list. For international investors, the picture is not much different. Fixed income and metals funds hold the top ranking. One pocket of strength from earlier in the summer (South East Asia Equity) is still evident. In our ETF portfolios, we see India (EPI) and Turkey (TUR) at the top of the list but with low readings that do not suggest an abundance of confidence amongst investors.

We recommend staying reasonably risk adverse and liquid with your portfolio and waiting for the “winds” to pick up before picking up higher risk asset classes. How will we know when the winds have changed? Sign up for our PortfolioSelect feature (open to Silver and Gold members) and let the Fund King System do the heavy lifting with the assets that you want to watch.

Portfolio Select

Filed under: Market Psychology

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