In a secular bear market, which is where I firmly believe we are today, there are three phases:

A phase I bear market (often referred to as the first down-leg) brings stock prices crashing down. From its high of 14,164 in October 2007, the Dow Jones Industrial Average crashed to 6,440 by March 2009—a 55% drop. This phase of the secular bear market is behind us.

A phase II bear market (often referred to as the “rebound,” “bounce” or “sucker’s rally”) started in March of 2009. The Dow Jones Industrial Average has risen 89% since March 9, 2009. The bear market has been doing an excellent job during this current phase of luring investors back into the stock market. Phase II bear markets give investors the false impression that the economy has turned the corner, that stocks are a safe bet again. This phase of the secular bear market is still upon us.

Given that 2012 is a Presidential election year in the U.S., given that the government and the Fed have fought the natural forces of the bear market tooth and nail, the bear market rally, the “bounce” in this secular bear market, has been long.

Phase III of the secular bear market is when stock prices come crashing down again, bringing stock prices down to the point at which the phase I bear market started or lower—in this case, 6,440 on the Dow Jones Industrial Average, about 50% below where the stock market sits today.

Yes, I’m sure many of my readers are sitting there, reading this, and saying, “Michael, this can’t happen. Our economy would crash again.” I also understand that I’m one of the few stock market analysts out there with this opinion. But history is history. What I have explained above, the stark reality of where we are with the stock market, is how a secular bear market works.

The government can take on as much debt as it likes (which is actually a terrible thing for the economy in the long term) and our central bank can increase the money supply as much it wants (another terrible exercise, as inflation and higher interest rates are always the end result of too much money printing). The natural forces of a secular bear market will eventually play themselves out.

Michael’s Personal Notes:

What will happen to the U.S. housing market in 2012?

As we close out 2011, we will have experienced the fifth consecutive year that home prices in the U.S. have declined. According to the popular S&P/Case-Shiller Index,U.S. home prices are down 31% from their mid-2006 peak.

Several reports have been circulated stating that the bottom for home prices is in or will be in sometime in 2012. And there are still those who expect 2012 to be the sixth consecutive year that home prices fall. A recent report from Freddie Mac says that home prices will fall one percent in 2012 and rise in 2013. Other analysts and economists have been more negative saying that home prices will fall up to seven percent in 2012. However, the majority do expect a bottom in 2012 or 2013.

As I have written before, home buyers can get a 30-year fixed mortgage in theU.S.today for 3.91%—the lowest interest rate on a 30-year fixed in 41 years! The problem is that the majority of would-be buyers can’t get qualified, because lending conditions have tightened.

There are several structure issues hindering the U.S. housing market:

A huge inventory of foreclosed homes overhangs the sector. For 2011, foreclosures by lenders of U.S. homes have consistently been in the 200,000 units per month range.

About one in four homes in the U.S. that have a mortgage are worth less than the mortgage.

The attitude toward home-ownership has changed. The rental market is booming in many states. Consumers don’t want to get burned again or, in many cases, they simply don’t have the down payment or creditworthiness to qualify for a mortgage to buy a home.

The tight lending practices of banks have not loosened. And I personally believe there are hundreds of thousands of defaulted home mortgages on the books of the big banks that have yet to enter the foreclosure process.

My prediction is for U.S. home prices to fall in the three percent to five percent range in 2012, with a comparative loss in 2013. But here’s where I differ from most economists on housing: I do not believe thatU.S. home prices will move up this decade.

The biggest creation of money that the U.S. central bank has ever undertaken—we are talking a money supply that has been increased by trillions of dollars—will eventually lead to rapid inflation. That inflation will lead to higher interest rates.

Home prices do not rise when interest rates rise—home prices have an inverse relationship to housing. I sincerely believe that we are near the beginning of a new 30- to-40-year uptrend in interest rates. The U.S. housing market will not recover for years and years. (See also: So They Say the U.S. Housing Market Is Getting Better? Read This.)

Where the Market Stands; Where it’s Headed:

“Inch by inch,” the bear market rally moves towards making 2011 another up year for stocks. As of this morning, the Dow Jones Industrial Average is up 5.3% for 2011. Add in an average dividend of 2.5% and, in spite of the markets’ whipsaw since May 2, stocks have returned a respectable 7.8% this year.

We are in bear market rally in stocks that started in March of 2009. The rally, a giant rebound from a stock market that basically crashed from December 2007 to March 2009, has been prolonged by the efforts of government to increase its debt and by an overly accommodative central bank. (See: Stock Market: What You Can Expect From It in 2012.)

What He Said:

“Over-built, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, April 3, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

What will happen to the U.S. housing market in 2012?

As we close out 2011, we will have experienced the fifth consecutive year that home prices in the U.S. have declined. According to the popular S&P/Case-Shiller Index,U.S. home prices are down 31% from their mid-2006 peak.

Several reports have been circulated stating that the bottom for home prices is in or will be in sometime in 2012. And there are still those who expect 2012 to be the sixth consecutive year that home prices fall. A recent report from Freddie Mac says that home prices will fall one percent in 2012 and rise in 2013. Other analysts and economists have been more negative saying that home prices will fall up to seven percent in 2012. However, the majority do expect a bottom in 2012 or 2013.

As I have written before, home buyers can get a 30-year fixed mortgage in the U.S.today for 3.91%—the lowest interest rate on a 30-year fixed in 41 years! The problem is that the majority of would-be buyers can’t get qualified, because lending conditions have tightened.

There are several structure issues hindering the U.S. housing market:

A huge inventory of foreclosed homes overhangs the sector. For 2011, foreclosures by lenders of U.S. homes have consistently been in the 200,000 units per month range.

About one in four homes in the U.S. that have a mortgage are worth less than the mortgage.

The attitude toward home-ownership has changed. The rental market is booming in many states. Consumers don’t want to get burned again or, in many cases, they simply don’t have the down payment or creditworthiness to qualify for a mortgage to buy a home.

The tight lending practices of banks have not loosened. And I personally believe there are hundreds of thousands of defaulted home mortgages on the books of the big banks that have yet to enter the foreclosure process.

My prediction is for U.S. home prices to fall in the three percent to five percent range in 2012, with a comparative loss in 2013. But here’s where I differ from most economists on housing: I do not believe that U.S. home prices will move up this decade.

The biggest creation of money that the U.S. central bank has ever undertaken—we are talking a money supply that has been increased by trillions of dollars—will eventually lead to rapid inflation. That inflation will lead to higher interest rates.

Home prices do not rise when interest rates rise—home prices have an inverse relationship to housing. I sincerely believe that we are near the beginning of a new 30- to-40-year uptrend in interest rates. The U.S. housing market will not recover for years and years. (See also: So They Say the U.S. Housing Market Is Getting Better? Read This.)

Where the Market Stands; Where it’s Headed:

“Inch by inch,” the bear market rally moves towards making 2011 another up year for stocks. As of this morning, the Dow Jones Industrial Average is up 5.3% for 2011. Add in an average dividend of 2.5% and, in spite of the markets’ whipsaw since May 2, stocks have returned a respectable 7.8% this year.

We are in bear market rally in stocks that started in March of 2009. The rally, a giant rebound from a stock market that basically crashed from December 2007 to March 2009, has been prolonged by the efforts of government to increase its debt and by an overly accommodative central bank. (See: Stock Market: What You Can Expect From It in 2012.)

What He Said:

“Over-built, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, April 3, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

Looking towards 2012, many investors are worried about their assets. Europe is in disarray, the U.S.debt is continuing to balloon, unemployment levels remain high, and no real concrete steps have been taken by political leaders to stem the negative sentiment. With all of this pessimism, in my opinion, this is a great buying opportunity for the long-term investor to acquire solid companies.

Generally speaking, you want to buy when people are selling, and sell when people are buying. The ICI, Investment Company Institute, tracks the flow of money into mutual funds. With December numbers in, the ICI reports that investors have been pulling money out of domestic mutual funds in every month since May; a total of $132 billion. That is a huge amount of money to be pulled out of the market, a sign of negative market sentiment. But, historically, when so many people have sold their stocks, it has provided a great buying opportunity.

Let’s take a look at recent history and see what has happened. We see a massive amount of money being pulled out of domestic mutual funds between September 2008 and March of 2009; again, poor market sentiment. The bottom of the market was March 2009. By looking at this one indicator of market sentiment, you can’t pick the exact top or bottom, of course. It is merely a tool to show you where the mass crowd of investors is moving their funds, but it gives you an idea that we’re closer to the bottom of the market. For someone with a long time horizon who averages into their trades, the aforementioned period in 2008-2009 represented an outstanding buying opportunity in stocks.

Let’s take a quick look at howU.S.corporations are performing. They are extremely strong, generating good profits and huge amounts of cash. By most accounts, corporations have three times the cash level they did 10 years ago. The dividend yield on the entire market, the S&P 500, at 2.47% is far above the 10-year U.S. Treasury yield of 1.9%. You are getting paid to invest in 500 of the largest corporations in the U.S. that are growing and flush with cash compared to the yield on a piece of paper from the U.S. government, which has astronomical levels of debt. This is shortsighted thinking from scared investors with negative market sentiment, which provides smart investors another buying opportunity.

A report by Barron’s showed the difference in yield between the earnings of S&P 500 companies, 8.6%, and the yield on 10-year U.S. Treasuries, 1.9%. This difference is the widest level—6.7%—than at any period since 1975! That was also a great buying opportunity in stocks!

For most of the last three decades, this spread has been zero. This indicates that people are scared, reflecting in negative market sentiment, selling their stocks and parking their cash in U.S. Treasuries. That will not last forever. When the shift occurs the other way, you will see the cash start moving back into stocks and pushing prices back up to “normal” valuation levels.

One area an investor should assess is their risk tolerance and time horizon. The indicators using money flow are very long-term in nature. From the beginning of money being pulled out of the market in the fall 2008, we saw the top in the S&P 500 occurring in the spring of this year, a period of just over two years. In the short run, there will be many fluctuations. Currently we’ve seen a large number of advisors become more bullish as the market moved up off the lows this year in October. In the short run, this may indicate that the market has gone a bit too far too fast. Patience is a virtue when investing for the long run.

Make no mistake about it; there are a lot of potential problems over the next decade. No one can know for sure what will happen. If we use history as our guide and someone were to buy when everyone else was scared and selling, there is a significant buying opportunity at those moments of extreme negative market sentiment.

A year ago, Wall Street was giddy and called for a strong up year for stocks. I was also in that camp, but thought technology and small-cap stocks would be the market drivers. Fast forward a year and here we are at the Christmas break…and it has not been as forecast.

The S&P 500 sits at 1,242 at the close of December 21. A year earlier, the Wall Street bulls, such as Bank of America Corporation (NYSE/BAC), predicted strong moves for the S&P 500 to 1,400, driven by technology and energy. So, unless the S&P 500 can rally 11% next week, Wall Street has miscalculated.

Some of the other Street estimates for the S&P 500 were even higher. Take a look.

J.P. Morgan: S&P 500 1,425

Barclay Capital: S&P 500 1,420

Goldman Sachs: S&P 500 1,450

As I said, last year at this time, I said, “I expect tech and small-caps to drive trading again in 2011.” It looked that way earlier in the year, but then the European debt crisis materialized,Chinashowed some stalling, and stocks began to sink quickly. In 2010, there were some rumbling concerning the weak condition of some of the banks inScotland, but clearly there was not a firm indication that the eurozone debt issues would magnify quite so much.

Domestically, the housing market failed to really improve all that much in 2011, especially with home prices continuing to decline acrossAmerica. President Barack Obama signed an $858-billion package to extend tax cuts for an additional two years and unemployment benefits that were set to expire. The package was aimed at driving consumer spending and growth, but it has fallen well short of any sustained growth. The jobs market remains a major issue.

The lack of any leadership was the downfall for many in 2011. The big banks failed to attract buying, while technology had its moments, but overall failed to inspire traders.

The index charts at this point are vastly different from a year ago when the major stock indices edged higher breaking the successive chart tops. At this point, we are seeing an intermediate downtrend with tough upside resistance that will make it difficult.

Europe continues to be a major hurdle, as I see more problems brewing down the road, especially with some of the PIIGS (Portugal,Ireland,Italy,Greece, andSpain) countries.

Chinais stalling.China’s GDP estimates for 2012 range from as low as 6.5% to as high as 9.5%. Comparatively, this range is superior to domestic GDP growth of 1.8% in the third quarter. I continue to favorChinaheading into 2012 and over the next several years, as long asEuroperegenerates.

The next several weeks after January 3, I will take a look at the global environment and offer you my forecast on what to expect for 2012. But right now, with only a few trading sessions left for the year, I advise taking some profits prior to the year-end. In addition, take a look at some of your losers if you want to absorb some losses to be used against your gains.

Read what I have to say about the alternative energy sector and a company that is trying to benefit from the electric car movement in The Alternative to Being Held Hostage by Oil-rich Countries.