As a reader of this column, you are aware of my opinion:

A long-term bear market was started in October of 2007. Phase I of the bear market took stocks to a 12-year low on March 9, 2009. On March 9, 2009, we entered Phase II of the bear market…a period where stock prices move back up in a bear market rally so investors are lured back into the stock market.

We have yet to enter Phase III of the bear market, that’s when stocks go back down to their bear market low…in this case, 6,440 on the Dow Jones Industrial Average.

This summer, after several big days of 400- to 500-point drops in the Dow Jones Industrial index, many stock advisors and investors were throwing in the towel on the stock market. I told my readers to hold firm…that the stock market rarely follows what is expected of it. And that’s what the stock market has done; it’s failed to listen to forecasters and it just continues to climb the wall of worry higher (see Strongest Indication Yet That Stocks Are Short-term Oversold).

So what happens next?

I believe that the bear market rally will continue to bring stock prices higher for the remainder of the year and that 2011 will be another winner for the stock market. However, as the market moves higher, investor optimism will return and the bear market will have achieved its goal of bringing investors’ confidence back…luring investors back into stocks.

As Phase III of the bear market takes hold and stock prices start to fall, the Federal Reserve, I believe, will unleash QE3. Last week, Bank of Chicago Federal Reserve President Charles Evans called for more Fed action to spur the economy. Federal Reserve Vice-Chairman Janet Yellen has been hinting at another round of quantitative easing.

A further increase in the Fed’s balance sheet and more government spending will simply decrease the value of the U.S. dollar against other world currencies and increase the price of gold bullion, which will be an opportunity for investors (see Answered: Can I Still Make Money Buying Gold Now?).

But, despite the actions of the government and the Fed, they will be unsuccessful in taming this final phase of the bear market, which I believe will get underway in 2012 and bring with it an unpleasant surprise: inflation (see Economic Analysis: And Then Came Rapid Inflation).

Michael’s Personal Notes:

When President Obama leaves office, he will have accomplished several things, both positive and negative. On the economic front, two negatives are stuck in my mind:

Under the Obama Administration, the U.S. national debt will have risen approximately $5.0 trillion—that’s almost a 50% increase from when President Obama took office and the biggest four-year increase in the U.S. national debt under any President.

Secondly, Obama will leave Washington the wealthiest U.S. metropolitan area. According to Bloomberg News’ calculations of U.S. Commerce Department Data, Federal employees’ average annual compensation is now about $126,000. The unemployment rate in the Washington metro area is about 6.1%, compared to 9.1% nationally.

Washington, which is home to the largest concentration of lawyers in America, has bumped Silicon Valley as the area with the highest average family income (Source: U.S. Census Bureau).

There were two ways to fight the recession and the credit crisis: increase the U.S. national debt and have government spend its way out of the recession; or let the too-big-to-fail companies fail…let the economy hit bottom…and have it come back on its own. The Obama Administration chose the easiest path. And, in all reality, any government presiding in Washington would have chosen the path the Obama Administration did. Increasing the U.S. national debt to help the economy was the easiest, less painful way.

It was John Maynard Keynes who, way back in the early 1900s, popularized the use of fiscal and monetary policies to stimulate the economy. The governments of most developed countries have been advocates of Keynes’ work. Economists, like me, believe that Keynes was wrong in his work. The economy should be able to expand and contract itself without interference from government. Bull markets and bear markets should play themselves out, I believe. Government interference often leads to waste and an increase in debt, in this case, U.S. national debt.

My message today is that the actions of the Obama Administration and the Fed have simply delayed the inevitable—the washout of the great economic leveraging that took place from the early 1980s through to 2007—and increased the U.S. national debt to our long-term detriment.

Hence, this is why I believe that, once the bear market rally that started in March of 2009 is over, the bear market will likely test its low set on March 9, 2009 of 6,440 on the Dow Jones Industrial Average. The bear market isn’t over; it’s just been delayed from completing its cycle…and that when Phase II of this bear market has been so long.

Where the Market Stands; Where it’s Headed:

I felt like I was the lone bull this summer. As most of my contemporaries were calling the stock market rally finished and hailing the arrival of a second recession, I was steadfast in my belief that the bear market rally that started in March 2009 had life left in it. I believe Friday’s big-bounce stock market action has vindicated me.

The Dow Jones Industrial Average opens this morning up two percent for 2011. I believe that the Dow Jones has a good chance of breaking past the psychologically important 12,000 level, as the bear market rally moves higher on the backdrop of investor and stock advisor pessimism, stronger than expected corporate earnings, and lack of investment alternatives.

What He Said:

“Home-building in the U.S. will enter a quasi depression state in 2008 and the construction industry will make 2008 a record year for pink slips. I predict a major homebuilder will go bankrupt in 2008.” Michael Lombardi, PROFIT CONFIDENTIAL, January 10, 2008. WCI Communities, the largest U.S. luxury homebuilder, filed for Chapter 11 protection on August 4, 2008.

Tags: Bear Market Rally, federal reserve, Phase II bear market, Phase III bear market, stock analysis, stock market, U.S. national debt