Recently, bank stocks have taken big hits following news of the trading debacle involving JPMorgan Chase & Co. (NYSE/JPM), causing the firm over $2.0 billion in losses. This has caused a market sector selloff across the entire investment banking space. But some interesting developments have occurred with some bank stocks.

The Goldman Sachs Group, Inc. (NYSE/GS) has recently disclosed that it actually increased its holdings of Italian sovereign debt. This was offset by selling Italian bank stocks. This is a very interesting trade. As of March 31, 2012, exposure to Italian government debt was over $8.0 billion, as opposed to just over $3.0 billion at the end of December 31, 2011. Conversely, Goldman reduced its holdings of Italian bank stocks to only $623 million, as opposed to almost $7.0 billion as of December 31, 2011.

Goldman Sachs is building a large inventory of Italian debt in its thinking that clients will want further exposure to sovereign debt versus holding Italian bank stocks. Many bank stocks in Europe continue to need more recapitalization and this will weigh down their share price for some time. Short-term sovereign debt of less than three years is actually backed by the European Central Bank (ECB), so is seen as a safer trade than the bank stocks. In that regard, Goldman has made a shrewd decision to avoid bank stocks in Italy, as I definitely see more problems arising in the future.

Goldman Sachs has been hit recently as well as many other bank stocks in a selloff across the entire market sector. However, over the long run, Goldman Sachs has found a way to produce profits over the long term. Within the market sector of bank stocks, Goldman has usually been a leader in generating trading profits. An example is can be seen by looking at the last quarter in which Goldman reported only one losing day; conversely, it also reported 24 days of gains of at least $100 million.

The possible downgrades by Moody’s Investor Service are worrisome for Goldman shareholders, triggering additional payments and collateral. The company is also pulling money from hedge funds ahead of the new banking regulations called the “Volcker Rule.”

Chart courtesy of www.StockCharts.com

The stock is currently under pressure, as is the entire market sector. I would avoid bank stocks that have large amounts of unknown exposure. In general, this market sector is looking very weak and I don’t believe in catching falling knives. Right now, with the turmoil in Europe, who knows exactly what these bank stocks hold in their portfolios.

Looking at the chart of Goldman Sachs, I don’t see a drastic move up; in fact, I see a continued selloff until a base is formed. All of the support levels have been breached and the downward move is accelerating. Some might indicate that an oversold condition, as noted by the circled Relative Strength Index (RSI), is currently underway. While I do agree that the stock might temporarily bounce, I see all signs that any move upwards will be met with considerable selling pressure.

At this point, I would probably avoid this market sector for most of 2012. Once new regulations are enacted, then we can try to tackle what the true value for these bank stocks is. Don’t forget; with Europe falling apart, there are billions of dollars in credit-default swaps (CDS) that could blow up and take this market sector down even further.

The stock market risk is high right now. Maybe you should take a vacation from investing.

As an investor, you should be aware that the six-month period from May to October has been historically the worst-performing months for stocks, according to the Stock Trader’s Almanac. And so far, this stock market risk and historical pattern appears to be staying true to form.

The charts continue to be bearish. I said this in March and in April. I had sensed some near-term topping action several weeks back, as the stock market risk intensified after several attempts to move higher failed to be sustainable. For instance, the S&P 500 at 1,400. Moreover, the lack of volume on up days has been a major red herring and stock market risk for the buy side—indicating a lack of mass market interest.

The key stock indices have been devoid of any momentum or signs of sustained buying interest—down in the red over the past five days and month.

And, while stocks continue to hold in positive territory for 2012, the key stock indices are in the red since the end of March below their respective 50-day moving averages. Technology stocks, which fared the best this year, had been up over 18% in March, but have seen gains dwindle down to just over 11% on higher stock market risk. The NASDAQ is down 6.11% since the end of the first quarter, only trailing the 6.27% market correction in the Russell 2000.

The overall Relative Strength is weak, indicating that more weakness may be in the works or the upside gains may be limited, but watch for some oversold buying support. The breach of the 50-day moving average was bearish and points to higher stock market risk. Continued weakness could trigger additional selling and drive the key stock indices to test their respective 200-day moving averages.

The underlying strength as indicated by the advance-decline line for both the NYSE and NASDAQ has been trending lower since the start of May—indicating a loss of momentum. The following chart of the NASDAQ Advance-Decline reflects the weakening position and stock market risk.

Chart courtesy of www.StockCharts.com

The fragility and stock market risk on the charts are deserved in my view.

China and the eurozone remain major areas of stock market risk, which I had previously discussed in Global Market Risk: Is it Improving?

It appears that Greece may fall out of the eurozone and euro, as I have said in my past commentaries. The reality is that Greece is a weak player and it will take decades likely for the country to pull out of its mess. In fact, it could even worsen if the tough austerity programs fail to deliver debt cuts and cost control. Germany, which is fighting its own GDP growth issues, is not interested in funding anymore funds to Greece and clearly wants to focus on its own economy.

And then there’s Spain with its rising bond yields. The 10-year auction showed yields of 6.22%, which are not sustainable for Spain and its troubled debt and muted growth. The high yields are an indication of potential problems down the road.

Italy 10-year bonds are yielding 5.75%.

Note the pattern here?

What about the eroding situation in China? While the new rich Chinese from the mainland flock into Hong Kong and buy expensive goods, China may be a time bomb.

Filings from Wind Information indicate that around 45% of China companies listed on the Shanghai and Shenzhen stock exchanges provided weak forecasts for the first half. In my view, this is a real and valid concern that needs to be monitored.

The warning signs are there as far as the stock market risk, but I hope it’s not the perfect storm!

Unless we get a major shock like war or something related to the sovereign debt crisis in Europe, I don’t think the stock market is going to experience a lot of further downside. Stock prices might drift and then trade range-bound for a couple more months, but stock market valuations are fair and this provides a lot of cushion.

I do think there is more downside potential in gold, silver and oil prices and it’s not just related to slower growth in the global economy. A lot of the price weakness in these commodities is related to strength in the U.S. dollar, which experiences renewed enthusiasm every time there’s an uncertain development in the eurozone.

There remains, in my view, an underlying strength to the stock market at this time. Institutional investors want to be buyers in this market; they only need a reason to do so. I fully expect that large-cap companies that pay dividends will continue to be the market leaders going into 2013, because, in a slow growth environment, dividends income is crucial. I think it’s fair to conclude that expectations for capital gains are fairly low among all stock market investors, so dividends become the only way to beat the inflation rate.

Because we’re now in the lull between earnings seasons, increased dividends announcements are reduced. I think we’ll get another round, however, during second-quarter earnings season, largely because companies can and want to keep shareholders happy. The cash hoard among most large-cap companies remains substantial.

When share prices go down, yields for dividends go up of course. Most of the stock market’s leaders haven’t actually pulled back in price to a very large degree and this contributes to my view that there is solid underlying strength in this stock market. (See Stock Market Correction’s Here—Put Dividend Paying Stocks on Your Radar Screen.) And the fact that stocks are fairly valued suggests to me that further downside will be modest.

Practically, the only thing that equity investors can really count on in this market is dividends income. Things could blow up in Europe, China’s economy could slow even further, or there could be another war in the Middle East. In any scenario I consider, I just don’t see GDP growth accelerating very much. This is why I’m so pro-dividends. Dividends income is the best bet for new investible money in the age of austerity. Everything else, like gold or oil stocks, you have to get timing right in order to make money. With large-cap dividend paying stocks, all you need is the patience.

U.S. consumer credit jumped in March 2012 by the most in over a decade (source: Bloomberg, May 7, 2012).

Sure, we heard the usual bullish economists and election-hungry politicians say, “Here’s proof that consumer spending and consumer confidence is improving.”

But a look closer look at the number reveals more of the same for consumer confidence and what’s ahead for the remainder of 2012…

The big jump in U.S. consumer credit in March didn’t come because of consumer spending; the big jump came as a result of more student loans and more car loans.

With the U.S. unemployment rate high and youth unemployment at 13.2% here in the U.S. (source: Bureau of Labor Statistics), it is no wonder people who cannot find work are returning to school. This doesn’t feel like consumer confidence to me. (Also see: U.S. Durable Goods an Ominous Sign.)

Congress is thinking of raising interest rates dramatically on new student loans taken after July of this year; hence people are jumping on the “go back to school” bandwagon now.

As for those car loans, financial company Nomura Group just released a research note stating that the average age of cars on the road in the U.S. is more than 10 years old—the oldest on record!

The research goes on to say that strong buying of new cars is probably a necessity and not a reflection of true consumer demand, because the old clunkers will simply give out at some point.

Doesn’t sound like a vote for consumer confidence or for consumer spending going forward.

I have written in these pages about multiple studies here in the U.S. that have detailed the plight of the average American; namely, dipping into their savings or borrowing to make ends meet.

There is another study that has just been released that puts a damper on the supposed consumer confidence and consumer spending recovery.

Connecticut-based LIMRA Research conducted a survey the results of which found that 49% of Americans were not saving for retirement. More than half of those who weren’t contributing said they couldn’t afford to. An incredible 56% of those surveyed, from the ages of 18 to 34, said they were currently not contributing to a pension plan.

This is a retirement crisis, as these people will have to work during their retirement to make ends meet. How can we get consumer confidence going under this scenario?

Forget what the mainstream media and politicians are telling you; this is not a sign of consumer confidence, but consumer distress. This is not a sign of future consumer spending, but of spending contraction. (See: “Economic Recovery” Theory Debunked.)

How will the balance of 2012 go? Terrible. If the economic statistics are any indication, consumer confidence seems to be an illusion. As I have been predicting, the economy will deteriorate as we move along in 2012.

A recession is sailing into America. I just can’t figure out if it coming across the Atlantic from recession-ridden Europe or across the Pacific from economically slowing China.

Michael’s Personal Notes:

Do the politicians really have any idea what is going on?

It was only a few weeks ago that the prime minister of Spain said the country’s banks were so sound that they required no government bailouts.

Fast forward…

Last week, the government of Spain was forced to provide a government bailout for Spain’s third-largest bank; the bank with the greatest exposure to the collapsing Spanish housing market.

The problem is that Spain’s economic expansion prior to 2008 was based on a housing market boom. Spain’s banks were overleveraged in their lending practices. That is, for example, they lent out $6.00 for very $1.00 of money they actually had on their books.

In good times (like in the U.S. prior to 2007), the banks can handle this leverage, because the housing market is moving up. But when the market collapses, there is no money to pay for that debt; hence the government bailouts.

Unfortunately, unlike the U.S. that can print money to bail out its banks, Spain cannot provide the government bailout money required, because it simply doesn’t have the money to do so. The (central) Bank of Spain is saying that the amount that Spain would need to put aside to help its troubled banks is €175 billion. But what the government bailout provision leaves out is that there is €1.4 trillion in loans that are vulnerable (source: Bloomberg, May 10, 2012).

A staggering amount of corporate and housing market debt is in jeopardy, because the Spanish banks are in trouble. The main reason why Spain’s banks are not making money is that Spain is in a recession. In the first two quarters of 2012, Spain’s GDP contracted 0.3%.

While the Spanish economy contracts, one-in-four people in Spain are unemployed and one-in-two young people are unemployed!

With the government admitting that economic growth is continuing to fall, this puts pressure on corporations in Spain and on their debt, which the Spanish banks are exposed to, potentially requiring further government bailouts.

The Spanish housing market has lost 30% since 2008 and shows no signs of slowing as more homes are left empty and the high unemployment rate is pushing prices lower. This means the housing market debt on the books of Spain’s banks is worth less and less.

Although the Spanish government is putting on a brave front, the only way it can support the €1.4 trillion in debt is if its revenues increase or it prints money. With one in four people unemployed in Spain, government revenues are falling, not rising. As for money printing, Spain is part of the eurozone. Germany is steadfastly against printing euros because of the inflation risk money printing presents.

If this seems like a perfect death spiral, wait; there’s more!

Germany understands what is occurring and realizes that the Spanish government is going to need a government bailout from Europe, because the Spanish government doesn’t have enough money.

Germany wants Spain to stick to the austerity measures and so reduce its budget deficit. With a contracting economy and high unemployment and with government bailouts of the banks, this will not be possible.

Yes, it is a perfect death spiral. The European Union is falling apart at the seams. This will put further pressure on the earnings of American corporations and on the U.S. stock market.

Where the Market Stands; Where it’s Headed:

We are in a bear market rally in stocks that started in March of 2009. The rally is now more than three years old, so I would classify it as a typical post-crash rally. However, the bear market rally is getting old and tired.

While the purpose of a bear market rally is to lure investors back into stocks (this rally has done an excellent job of it), there are now clear signs that economies worldwide are slowing. We are getting close to a top for stocks unless the Fed drops QE3 on us faster than we thought it would.

What He Said:

“I’m getting very worried about the state of the U.S. housing market and its ramifications on the economy. The U.S. could be headed for its first outright annual decline in home prices on record, adjusted for inflation. And I really believe this could be a catastrophe for the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, August 2, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.