China is the country with the largest population in the world at over 1.3 billion people. The land covers approximately 3.7 million square miles. The country is governed as a communist country, although they have developed a quasi-capitalist sector for business. China has the second largest gross domestic product (GDP) at approximately $7.0 trillion; behind the U.S. at $15.0 trillion and ahead of Japan at $5.8 trillion. The leaders opened up the centrally planned economy in the late 1970s and early 1980s to allow economic growth through trade, which has allowed China to grow at an unprecedented rate for a country its size. From 2001 to 2011, China grew at an annualized rate of 10.5%.

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.

Since 1945, Greek elections have swung back and forth between two parties, similar to the Republicans and the Democrats here in the U.S.—very predictable.

With the Greek unemployment rate at a record 21.7% in February and youth unemployment at an alarming 54%, the elections in Greece held earlier in May saw this 60-year political cycle come to an abrupt end.

The parties that support the European Union and the austerity measures—and the parties that traditionally held power for over 60 years—only garnered 34% of the vote. The other minority extreme right-wing and left-wing parties, which gained seats as a consequence, stand against the European Union and the austerity measures.

Greek law states that the minority party with the most votes must attempt to form a coalition government in order to run the country. The party in support of the European Union and the austerity measures was, of course, unsuccessful in forming a coalition government.

According to Greek law, the party with the second-most votes is next to try to form a coalition government. Although these extreme parties are against the European Union and the austerity measures, their ideals are so different that they were unable to form a coalition.

Now that this has failed, Greek law states that another election must be held in the hopes of finding a majority government. This new election should take place sometime in mid-June. Of course, there is no way that the pro-European Union groups will get elected. The question is: will the people of Greece provide either the more extreme left- or right-wing parties with enough seats to run the country?

The European Union has already responded to this shift in Greek politics by saying that, if they don’t implement the austerity measures required of them, the country will not get any further bailout money. And if Greece does not receive the bailout money, it will be in default and will risk having to leave the European Union.

This situation is further complicated by the fact that certain interest payments on Greek bonds are due this week. Will Greece be able to pay for them? If the country doesn’t pay, it will be in default and could cause a cascade of events that may lead to Greece having to leave the European Union.

I can see the European Union holding together even if Greece leaves, as everyone has been painfully aware over the last few years that Greece will be unable to pay its massive debt.

However, besides Germany, there are not many other countries that are happy with the austerity measures. Therefore, will Greece leaving make Spain, Italy, Portugal, Ireland and now France take their leave of the European Union?

The other issue is that, if Greece defaults on its debt, well, someone is going to lose a lot of money. That someone could be a German or French bank. Also, the derivatives tied to Greece defaulting mean that someone will lose a lot of money. The European Union may need to step in and print who knows how much money to contain the crisis.

This mess is cloudier than trying to look through a body of water after an oil spill.

Compounding things…Ireland is holding a referendum at the end of May to vote on the austerity measures imposed on it by the European Union. Will Ireland indirectly vote to leave the European Union?

The situation in the European Union continues to erode. For the first time, one euro trades below $1.30 U.S. With so many U.S. S&P 500 companies having revenue exposure to Europe, is it any wonder the stock market has been in a free-fall as of late?

Michael’s Personal Notes:

When the competitors of Cisco Systems, Inc. (NASDAQ/CSCO) reported weaker first-quarter 2012 earnings, market participants bid up Cisco’s stock believing that Cisco was taking market share away from its competitors.

Polycom, Inc. (NASDAQ/PLCM), a videoconferencing company, reported weaker first-quarter earnings. This competitor to Cisco noted that lower government spending caused revenues to decline more sharply than anticipated.

The company also provided its earnings outlook for 2012. It noted that the economic landscape looked weak. It cited business in North America and in Asia as being weak. This earnings outlook flies in the face of those who say that the U.S. economy will remain strong, despite what the rest of the world is doing.

Juniper Networks, Inc. (NYSE/JNPR) is a major communications equipment maker, the main competitor of which is Cisco Systems. Juniper’s earnings outlook for 2012 was provided with a very cautious tone. The company believes that the slowing U.S. economy and the European debt crisis are preventing telecommunications companies from spending, which in turn will affect its bottom line.

Many traders thought it is easy to blame a weak U.S. economy and the European debt crisis on a weak earnings outlook when Cisco is taking market share.

Cisco System reported earnings last week, which were fine, but its earnings outlook for 2012 painted the picture of a very nervous business sector that was unwilling to spend on Internet gear and a weaker global economic environment.

Despite the cash large corporations have on their balance sheets, they are not spending. Cisco noted that the European debt crisis not only meant weaker consumer and business spending in Europe, but it is also preventing large corporations from spending here in the U.S. and in Asia because of the perception of a coming global economic slowdown.

Yes, business in Asia was strong in the quarter for Cisco, but the company is uncertain about its earnings outlook in Asia going forward. Cisco is considered a leader in the technology space and its earnings outlook is a barometer of how the economy is doing.

Cisco also noted that weak government spending in the U.S. and in Europe—with the European debt crisis—was also an issue that was going to persist in 2012.

Due to Cisco and other technology firms’ weak earnings outlook, Internet technology spending growth worldwide has been slashed by many forecasters and analysts for the remainder of 2012.

There are clear signs the U.S. economy is weakening considerably (see: The Missing Economic Recovery), especially when considering the earnings outlook for the remainder of 2012 from key companies within the S&P 500. (Also see: Many Public Companies Predicting Soft Earnings for Balance of 2012.)

Where the Market Stands; Where it’s Headed:

After a great start to the year, May is proving to be a terrible month for stocks. The Dow Jones Industrial Average has dropped 518 points since the beginning of May.

Corporate insider selling of stock is at a record high. I’ve written repeatedly about the recessions amongst European countries and about the slowdown in China. Now corporate America is pulling back on its corporate earnings forecasts for the remainder of 2012.

Is this the end of the bear market rally that started back in March of 2009? We’ll soon see, dear reader, we’ll soon see.

Note on Gold:

Reports in the media have it that investors are unloading their gold and running for the “safety of the U.S. dollar.” I don’t buy this at all. Firstly, central banks have been big buyers of gold bullion in 2012. Central banks just don’t turn around and dump gold they just bought.

Secondly, the only “security” in the U.S. dollar is the fact that it’s a currency backed by a central bank that will simply print more of it in the event more dollars are needed. Money printing is something Germany has held the European Central Bank back from.

So you tell me, dear reader. Would you rather own a currency that is limited in circulation or one that is issued by a country that just prints more of it as needed?

Finally, after years of rising gold bullion prices, we are seeing a meaningful correction in the gold market. Gold is up five percent from where it traded one year ago. It’s all in the way you look at it and where you see inflation and the U.S. dollar in the next two to three years out.

I’m in the camp that sees the glass as half-full. When I could, over the past decade, during the bull market in gold bullion, I have been buying gold-related investments as the price of the metal corrected. I believe this strategy has worked well for me.

What He Said:

“Bonds could now be a buy: Bonds rise in price when interest rates fall, as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in PROFIT CONFIDENTIAL, July 24, 2006. The yield on 10-year U.S. Treasuries fell from five percent in the summer of 2006 to 2.4% in October 2011—doubling the price of the bonds Michael recommended.

China is rapidly become one of the top travel markets in the world for both domestic and international travelers. To deal with the increased travel, China has been steadily building its road, rail, and air infrastructure that will make travelling in this country much easier.

“China is the most attractive place in the world right now for hotels. That’s why investment capital is racing there and why the major international brands are racing there too,” said Patrick Ford, president of U.S.-based Lodging Econometrics, in an article on time.com.

China is the fourth top destination for tourism, but is expected to become the number one destination by 2020, according to the World Tourism Association.

The country is predicted to see major growth in its domestic travel from 2011 to 2013, according to a research report, China Tourism Industry Forecast to 2012, by traveldailynews.com.

China’s growth and travel industry are driven by a population of over 1.3 billion people and a steadily increasing middle class with money to spend on travel. As wages increase, so will the spending on non-essential items such as travel and recreation.

There is also a rising wave of foreign travelers that have made Asia and China premier travel destinations.

To handle the expected increase in travel, there is a push to build more hotels and motels across the vast country.

In the Chinese travel and hotel area, there are numerous operators that have excellent potential for the aggressive investor looking for growth areas.

Some of my favorite Chinese travel stocks include China Lodging Group, Limited (NASDAQ/HTHT), Home Inns & Hotels Management Inc. (NASDAQ/HMIN), and 7 Days Group Holdings Limited (NYSE/SVN). All three companies have above-average long-term share appreciation potential, but I will take a closer look at 7 Days Group today.

7 Days is the third largest national economy hotel chain. It offers limited services under the “7 Days Inn” brand, akin to budget hotels and motels in the U.S. and Canada.

As of December 31, 2011, 7 Days Group operated 944 hotels, up from 568 hotels a year earlier. The company has another 234 hotels under development. Currently there are 94,684 hotel rooms in 141 cities.

In 2011, the occupancy rates were between 81.5% and 87.9%, depending on the hotel.

The nine analysts who follow 7 Days Group estimate that the company will make $0.59 per American Depositary Share (ADS) in 2010, followed by profits of $0.82 per ADS in 2011, which are both higher than previous estimates. Revenues are predicted to grow 31.2% in 2012 and 24.4% in 2013.

7 Days Group may or may not have the greatest potential of the three stocks. Only time will tell, but what is for sure is that the travel sector in China is a key growth area.

Want to know some of the top U.S. restaurant stocks that are in China? Read about my ideas in The Top Three Restaurant Stocks in China.