Lombardi Publishing was originally established in 1986 as an investment newsletter publisher offering stock market guidance and analysis to readers. Today, we publish 25 paid-for investment letters most of which provide stock market guidance. Determining the over all direction of the stock market is very important—is it a bear market or a bull market—is first and foremost in our analysis. Profit Confidential is our daily free e-letter that goes to all our Lombardi Financial customers and to any investor who wishes to opt-in in to receive it. Written by Lombardi Financial editors who have been offering stock market guidance for year to Lombardi customers, Profit Confidential provides a macro-picture on where the stock market is headed. We start by determining if we are in a bear market or a bull market, based on that analysis, we look at what sectors are hot, what sectors to avoid. Our two most recent and popular calls were telling investors to bail from stocks in 2007 (the bull market was over and a bear market was setting in) and telling investors to jump back into the stock market in March of 2009 (a bear market rally was started).

The stock market and a number of commodities are in correction and this is no surprise at all. I want to repeat my view that all kinds of solid, growing gold mining companies are becoming very attractively priced right now and, as a sector, it’s worth putting gold stocks on your radar screen.

It’s a bit too early to jump right in with the spot price of gold likely to experience more downside. From a stock market perspective, most gold stocks began pulling back hard in mid-March, affecting even the best stocks within the sector. We’ve got to see the spot price of gold bottom out from its current downtrend and then I think we’ll have another really good entry point for considering new positions.

Investing in gold has always been a risky business, but it’s a worthwhile endeavor if you’re a stock market and commodities speculator. The key, like always, is to get the cycle right—timing in the investment business is everything. Even though the long-term trend might still be intact, the spot price of gold could easily go down to $1,200 or $1,100 an ounce. Why not? Gold has been in a bull market since 2002. The current price action in spot gold is very similar to the correction that occurred 2008/2009 and I wouldn’t be surprised at all if it repeated this trend: correction, recovery, consolidation, and then re-acceleration. It does take time.

Right now, there are large, medium and small producers of gold trading for reasonable prices on the stock market. A lot of these companies have little to no debt and are sitting on large cash hoards, waiting to put that money into new exploration and development. (See Everything Gold Is Turning Into Some Serious Green.) Even though gold stocks aren’t going up right now, it is an exciting time to be in this industry.

Speculating in gold mining stocks is a difficult business. You can find the best growth story out there, but if the spot price isn’t going up, then you aren’t likely to make any money. That’s why, as a stock market speculator, the majority of the time you need the spot price tailwind behind you. Or you go the other way and short these stocks when spot prices are falling. Just like in the oil market, spot price action is everything.

What I find attractive in a gold mining stock is finding a company that offer a “package” of good business fundamentals. This means that a gold mining company should already be producing and selling ounces of gold with detailed expectations for increased production over the coming quarters and years. The company should have other properties that it’s exploring, even in conjunction with other, perhaps larger mining companies. There needs to be a track record of financial growth, along with lots of cash in the bank for further exploration activities. Finally, a decent track record on the stock market is always helpful; it shows that institutional investors know about the business and are willing to invest and/or trade the stock.

I think we have more downside ahead in the stock market and in precious metals and other commodities. We’ve been due for a correction and here it is. I do see an underlying strength in the U.S. economy that, while not robust, is a good foundation for the future. For stock market investors, be prepared for further correction.

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.

Wow; 57.9 tons of gold bullion is a lot of gold.

And that’s exactly what they bought.

In March 2012 alone, 57.9 tons of gold bullion was purchased by world central banks. To give some perspective on this number, in 2011, central banks bought just under 440 tons of gold bullion, a rate of 37 tons a month (source: World Gold Council).

The International Monetary Fund (IMF) just reported that, in March, central banks took advantage of the lower prices in gold bullion to buy significant amounts of the metal.

Should the current rate of buying by central banks continue at this pace, central banks will purchase a staggering 700 tons of gold bullion in 2012!

As I’ve been writing in these pages, the gold demand from central banks does not include the largest central bank buyer: the People’s Bank of China. The Chinese are not reporting their gold-buying numbers to the IMF, but we know they are accumulating a staggering amount of gold bullion to back their currency, the yuan.

Over the last decade, the supply of gold bullion mined out of the ground has been fairly constant: 2,500 tons per year (source: World Gold Council). The fact is that gold bullion is difficult to find under the earth’s crust.

In 2010, central banks barely bought any gold bullion, while supply remained at 2,500 tons. In 2011, central banks bought 440 tons, with supply remaining relatively constant at roughly 2,500 tons. In 2012, at their current buying pace, central banks are on track to buy 700 tons of gold. And, if the People’s Bank of China continues to accumulate all it can, it is safe to say roughly half of the gold bullion supply will be picked up by central banks in 2012.

With supply steady and central bank buying increasing at a fast rate, gold bullion prices will have to move higher to satisfy other investor demand around the world. (See: Two Major Countries Join in China’s Quest for Gold.)

The reason central banks are buying gold bullion is that Japan’s weak economy may once force Japan to resort to money printing. The European Union is in crisis and will need to resort to money printing. The U.K. is now officially in a recession, which means it may be just a matter of time before it returns to money printing, as it has in the past in its attempt to resuscitate its ailing economy. (See: Money Printing by Any Other Name.)

As I’ve detailed in recent issues of Profit Confidential, the U.S. economy is not as strong as news headlines would suggest. As soon as the stock market starts to tank, QE3 will be announced.

With money printing seemingly the only solution to the world’s economic growth problems, central banks have decided to protect themselves by buying more gold bullion than ever before.

I suggest that my dear readers follow the example of world central banks and use weakness in the 10-year-old gold bull market as an opportunity to make gold-related investments. I would urge you to take a hard look at the senior gold mining companies; they are trading at historically low levels when compared to the current price of gold bullion.

Michael’s Personal Notes:

A perfect contrarian indicator may now be telling us that it is getting close to the time to sell stocks.

Alan Greenspan, who began the low interest rates policy at the Federal Reserve, said this week that stocks look very cheap to him, citing a low price-to-earnings (P/E) ratio for the stock market as the key reason.

He stated that stock prices will rise, as low interest rates provide few alternatives for income investors—so buy stocks now while they’re cheap.

Of course, he forgot to mention that the rate of corporate earnings growth has been decelerating at a very rapid rate. He also forgot to mention that artificially low interest rates, which he jump-started, make P/E ratios look better than they really are.

In the third quarter of 2011, corporate earnings growth, year-over-year, was 17% for the S&P 500. In the fourth quarter of 2011, year-over-year, corporate earnings growth was only 5.5%, even though interest rates remained at historic lows.

The corporate earnings numbers for the first quarter of 2012 are not all out yet, but they point to a continuation of a decelerating corporate earnings growth trend.

In my opinion, Greenspan, while Chairman of the Federal Reserve, kept interest rates at artificially low levels for a prolonged period of time after the economy had gained some traction in 2003 and 2004. Had he raised interest rates, he would have slowed the housing market, thus helping prevent the housing market from reaching bubble levels, and then crashing.

Greenspan argues in his best-selling book that the Federal Reserve is not as independent as people believe. He notes that there is huge political pressure on the Federal Reserve to keep the economic growth engine running at a fast pace.

Does this mean he is excusing himself for keeping interest rates artificially low because he had to bend to political will?

The focus when Greenspan was in office should have been on the real economy, which, as a consequence to this “political pressure,” allowed low interest rates and lax regulation to lead to the real estate crash and what is being dubbed the “Great Recession,” which we have yet to recover from here in America.

We are all entitled to an opinion. I was never a fan of Greenspan or his initial low interest rate policies. On the other hand, I’m a big fan of current Fed Chairman Ben Bernanke. I believe Bernanke saved this country from the Great Depression Part II.

As for Greenspan, when the housing market started to fall in 2006, I still remember him saying that the housing market contraction would be confined and would not affect the remainder of the economy!

Through the years, Greenspan has become a contrarian indicator for me. Just do the opposite of what he says and you’ll do fine. And if Greenspan is saying now is a good time to buy stocks, I know it’s getting close to the time to unload stocks.

Where the Market Stands; Where it’s Headed:

We are in a long-term secular bear market. Phase I of the bear market was completed when the Dow Jones Industrial Average fell from 14,164 in October of 2007 to 6,440 in March of 2009.

Phase II of the bear market started in March of 2009 and continues today. The purpose of a Phase II bear market (often referred to as a “sucker’s rally”) is to lure investors back into the stock market under the false pretense that the economy is improving.

Phase III of the bear market, the next phase, will bring stocks back down again.

What He Said:

“Recipe for Catastrophe: To me, the accelerated rate at which American consumers are spending, coupled with the drastic decline in the amount of their savings, is a recipe for a financial catastrophe.” Michael Lombardi in PROFIT CONFIDENTIAL, September 7, 2005. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

Just a few months ago, some economists were saying that the U.S. would escape the recession in Europe and the slowdown in China, to which I argued, “NOT A CHANCE.”

About 40% of all profits earned by the S&P 500 companies come from overseas (source: Bloomberg; April 9, 2012). When you look at that percentage, we quickly see it is impossible for American companies to withstand the recession in Europe and the slowdown in China.

Even the very big companies are complaining about problems overseas:

General Electric Company (NYSE/GE), the world’s largest maker of medical imaging equipment and an S&P 500 company, is warning that healthcare sales in Europe are going to be hurt by the recession they are experiencing in that part of the world, affecting GE’s earnings reports.

3M Company (NYSE/MMM)—another company within the S&P 500—is stating that the slowdown in China is going to hurt sales at its consumer products business there, thus affecting its earnings reports for 2012.

Due to the recession in Europe, The Dow Chemical Company (NYSE/DOW), a component of the S&P 500, shut down five factories and cut 900 jobs. This will lower the company’s profit growth when it releases its earnings reports throughout the year.

McDonald’s Corporation (NYSE/MCD) has yet to release any earnings reports in 2012, but this S&P 500 company says that same-store sales for February were lower due to Europe, as consumers there cut spending because of the recession.

Parker Hannifin Corporation (NYSE/PH), a manufacturer of fluid power systems and an S&P 500 company, cut its full-year profit estimates, well ahead of its earnings reports for 2012. The company cited slowing international demand for its products—Europe and Asia.

Staples, Inc. (NASDAQ/SPLS), also an S&P 500 company, reduced its profit forecast for 2012 due to the recession in Europe. On the U.S. economy, the company remains cautiously optimistic.

From the above, it is obvious that the slowdown in China and the recession in Europe have had significant impact on these S&P 500 companies. I have a strong feeling there are going to be many more earnings disappointments from large multinational American companies on the heels of higher commodity prices and slower international growth.

At the end of the day, the stock trades at a multiple of future earnings of the companies that trade in it. Weaker earnings growth by the S&P 500 companies with exposure to Europe and China coupled with record high corporate insider trading bodes well for my theory that we are simply in a bear market rally.

There is no substance to either the stock market rally or economic growth (domestic of international)—as the general public will soon so abruptly find out. (Also see: The Makings of a Classic Bear Market Trap.)

Michael’s Personal Notes:

I have been writing in these pages about the terrible plight of municipalities attempting to fix their massive budget deficits (see A Crisis Gone Worse: Many Municipalities Consider Bankruptcy).

The central problem with these budget deficits is pensions. Governments throughout the U.S. are desperately trying to find answers to the question of how to pay their obligations to retirees despite the fact that their pension plans are massively underfunded.

To avoid getting into such trouble, most corporations have almost completely eliminated defined retirement benefit plans. In 1983, 62% of all retirement plans offered were defined benefit retirement plans, but that dropped to just 17% in 2007 and probably fell a little more in the last few years (source: Boston College Center for Retirement Research).

Of course, there are still some unions left in this country, which will ensure the survival of defined retirement benefit plans. It is bad enough that the governments are unable to meet their massive budget deficits, but now corporations are in the same boat.

Since the financial crisis of 2007, new regulations were created, which forced companies to report their corporate profits differently. These measures were enacted in 2011 and, after one full year of reporting under the new standards, budget deficits for corporations were revealed when it comes to pensions.

Credit Suisse has analyzed the situation and believes pensions plans are only 52% funded. This means that, for every dollar of pensions owed, corporations in the U.S. have $0.52 in cash to meet these obligations through their corporate profits.

Credit Suisse estimates that the shortfall in pensions by corporations—budget deficits—comes to a staggering $369 billion.

Corporations can’t raise taxes like municipalities to meet budget deficits, but companies can either raise employee contributions to the pension plans to make up the budget deficits or cut the payouts of the pension plans. How well will that go over with unions?

You know the answer to that: Strikes and general animosity between the company and their employees, which will not be good for employee morale and in turn will reduce productivity, thus reducing corporate profits.

Seven large corporations within the S&P 500, including Safeway Inc. (NYSE/SWY) and United Parcel Service, Inc. (NYSE/UPS), have budget deficits when it comes to pensions that represent a significant portion of what they are worth today.

If these companies are forced to use a large part of their corporate profits to fill this budget deficit gap, their stock prices will suffer greatly.

Watch out for that stock market rally, dear reader.

Where the Market Stands; Where it’s Headed:

Dear reader, I want to be perfectly clear as to where I believe the stock market stands and where I believe it is headed:

After a 25-year bull market in stocks, which was fueled by a 25-year decline in interest rates and a period of great financial leveraging, a Phase I bear market (often referred to as the first down-leg) brought stock prices down sharply.

From its high of 14,164 in October 2007, the Dow Jones Industrial Average crashed to 6,440 by March 2009—a 55% drop.

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 about 100% 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 and that stocks are a safe bet again—exactly where we are today. 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 this 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 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 ($5.0 trillion and counting since President Obama took office) and our central bank can increase the money supply as much it wants (an increase of about $2.0 trillion since the credit crisis began). And you can bet your last dollar that there will be Q3 and that Phase III of the bear market will set in. But too much debt and too much money printing always lead to rapid inflation and higher interest rates. Hundreds of years of economic history have proven this.

What He Said:

“Consumer confidence does not change overnight. In the U.S., 70% of GDP is based on consumer spending. And in my life, all the recessions I have seen or studied have only come to an end when consumers started spending. With consumer sentiment getting worse, and with the U.S. personal savings rate near record lows, it may take two or three years for consumers to start spending again.” Michael Lombardi in PROFIT CONFIDENTIAL, February 25, 2008. By the end of 2008, the rest of the world was realizing the recession would be much longer and deeper than most had realized.

I think this year’s bull market is still alive, but it will take good corporate earnings and visibility to carry it forward. We’ve had a really good run up until now and the current price consolidation is not unexpected. I want to reiterate that the stock market is still very fraught with risks that are based on fragility in the U.S. economy and outside factors like the sovereign debt crisis in Europe and geopolitical concerns in the Middle East. I suppose these risks have been with us for years, but I know that investor sentiment is delicate enough to turn this stock market on a dime.

I still believe that a conservative investment stance is warranted and I would not be a big buyer of new positions in this stock market. In my view, the stock market is in the process of topping itself out after a long period of recovery from several big shocks. This doesn’t mean that the stock market won’t be higher at the end of this decade than it is now, but I do see a lot of problems over the next couple of years. Monetary stability, positive investor sentiment and reasonable equity valuations are responsible for carrying the stock market so far this year. What’s required going forward is confirmation in the economic news.

As part of a conservative investment stance, I’m a big believer in large-cap companies that pay dividends. Anybody reading this column over time knows this. The fact of the matter is that large-caps have performed exceptionally well since the financial crisis low in March 2009 and they’ve proven to be just as effective at generating impressive capital gains as traditional growth stocks. In fact, you can argue that traditional growth stocks don’t really exist anymore, because traditional economic growth isn’t a reality in the age of austerity. Regardless, I think stock market investors need to be very cautious in the current environment and that dividends are an investor’s only friend.

I’m looking for big dividends increases over the next two quarters, not runaway financial growth. Large-cap companies know that if they can’t generate both top- and bottom-line growth, they can keep institutional investors happy with increased dividends. It’s the best way to keep the party going.

Specifically, I’m expecting a dividends boost from the financial sector during first-quarter earnings season. We’ve already seen several announcements related to this. I think we’ll also get more dividends announcements from the technology sector and the industrial sector (like railroads), which are due to increase their payouts to shareholders. Regardless, if corporate visibility is murky, then increased dividends will be the only way to keep investors happy.

American Express Company (NYSE/AXP) announced a big dividend increase and the news sent its shares soaring. American Express is mimicking the S&P 500 Index almost exactly. (See Who’s Buoying up the Stock Market for 2012?) The stock is forming the right shoulder top of a traditional head and shoulders formation. With improved dividend news from large-cap companies, this little bull market can continue. Without it, I think we’ll get some drifting in the stock market throughout the second quarter.