For the benefit of my new readers, and as an update for my long-time readers, today I want to talk about exactly where I believe we are in the stock market.

 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 that accompanied collapsing interest rates, 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. 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 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’m sure many of my readers are sitting there, reading this, and thinking this can’t happen. 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 ($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). But too much debt and too much money printing always lead to rapid inflation and higher interest rates.

The natural forces of a secular bear market will eventually play themselves out.

Michael’s Personal Notes:

 There is no question in my mind that the Chinese economy will be the next great world economic power. While many still view China as mainly an export economy, the Chinese economy is already beginning to show that it is much more than that.

 I’ve been talking about how the Chinese economy is experiencing real wage inflation and that, in just a few short years, there will be no great cost advantage to manufacturers setting up in China as opposed to other major industrialized nations.

 This means that the Chinese economy can’t rely on its cheap labor as the sole means of attracting investment, because their labor costs will soon be comparable to labor costs of other developed nations. So what are the Chinese doing about this?

 Just this week, China opened its first car assembly plant in the European Union, in Bulgaria. Yes, a Chinese car manufacturer chose Bulgaria as its base from which to sell cars in the European Union, because of its low labor costs, low taxes, and well-educated workforce.

Where have we heard that before! Only a few short years back, it was U.S. and European car manufacturers and companies setting up in China. The tables have turned. The Chinese economy has grown up.

 The plant will be jointly operated by China’s Great Wall Motor Company and Bulgaria’s Litex Motors, just as other multinationals created joint ventures within China. The plant will eventually assemble 50,000 cars per year, and will initially sell in Bulgaria and neighboring Eastern European countries. The plan is to expand into the European Union.

 Within the Chinese economy, all Chinese automakers are expressing their desire to gain long-term strategic positions within Europe and the U.S.

This is just the latest venture into Europe. In 2010, China’s Geely Automobile Holdings bought Volvo from Ford Motor Company (NYSE/F), while the Chinese economy’s largest carmaker, Chery, owns a share of a Fiat plant in Italy.

 When people ask where the next great multinational companies will come from, dear reader, don’t forget about China. The Chinese economy has grown to the point where powerful companies have now emerged and are ready to take on the world.

 These Chinese companies are not just talking about it; they are taking action and making moves across the globe. The long-term picture for Chinese companies looks very bright. They have the money and are investing throughout the world in order to maintain strong earnings growth.

The Chinese economy and the companies within it are going to challenge the multinationals of both the U.S. and Europe. It might be a good idea, dear reader, to look at up-and-coming companies within the Chinese economy, the next great multinationals.

Where the Market Stands; Where It’s Headed:

It’s just a matter of time before the Dow Jones Industrial Average moves decisively above the 13,000 level. Stock advisor bullishness has pulled back a little (which is good for stocks) and economic news sounds encouraging for investors; maybe stocks are “not such a bad place” to park one’s money is the thinking I’m hearing from investors.

As I have been writing, there is no real “economic” reason for the market rally. The economy isn’t getting better. In my opinion, under the surface, the economy is deteriorating. What lie ahead are inflation and higher interest rates. The stock market has been kept alive the past three years by interest rates that are unnaturally low and an unprecedented expansion of the money supply.

The final stage of the bear market rally…that final blow to the upside…is being set up.

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 that 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.

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.

While we’ve had an uptick in manufacturing, retail, and housing starts, economic data are not strong enough to get investors to participate in the stock market. There remains a sense of gloom hanging over the economy with the very real possibility of a U.S. recession happening again next year. If this happens, then it’s fair to conclude that current stock market trading action is really just a bear market rally. In a sense, I think the same thing is occurring in the Main Street economy—it’s a bear market rally in economic activity after a sustained period of weakness.

Several times this year, we had a situation where most investable assets like the stock market, oil, gold and other commodities were trading in lockstep, particularly to the downside. It’s likely we’ll see this kind of trading action again in 2012, as investors come to terms with very slow economic growth. As investor sentiment fades, we could see another major migration to cash and bonds. It’s similar to the “forced liquidation” that Jim Rogers often refers to; and this makes it very difficult to formulate a portfolio strategy at this time.

The stock market today is experiencing a bear market rally, based on events regarding the eurozone debt crisis. As is the case with virtually all politicians, Europe is likely to get only temporary solutions, which unfortunately sets the stage once again for new shocks to the U.S. stock market. With this backdrop, stock market investors need to play a very strong defense over the near and medium terms.

The U.S. economy has proven over time to be exceedingly quick at correcting shocks to the system, but today we’re in a new paradigm—one that’s defined by debt. And, as we all know, getting out of debt isn’t that easy. At the sovereign level, even reducing the rate of growth in government debt has yet to be addressed. This is why I’m thinking that the stock market (which is in a breakout bear market rally right now) could tick higher going into the New Year; with growing risk of another forced liquidation of assets. Stock market investors don’t need to be buyers in this market and they don’t need to rush into commodities either. A bear market rally can suck investors in with the best of intentions, but the fundamentals aren’t yet good enough to go all in. Don’t forget; stocks have been in a bear market since 2000. A bear market rally is now commonplace.

We just completed a correction in the stock market (August to October 2011) and equities are trying to make a breakout right now. (See Investment Risk Going Up—It’s the Kind of Market Where Anything Could Happen.) This bear market rally might have legs until the end of the first quarter next year. I might be wrong of course, but my gut tells me that the current action is a trap. There is more reckoning to be had in the global economy, the stock market, and commodities before a new business cycle can begin.

How do I feel this morning? Vindicated.

I’ve been writing on these pages for months that the stock market has been in a bear market rally that started in March 2009 and that stock prices would move higher before Phase III of the bear market ultimately sets in and brings stocks back down to their March 2009 lows.

Over the past few weeks, I’ve been getting e-mails from my readers telling me that I’ve been in “bear market rally” mode for too long and that the markets were done…the bear market rally was over. And, presto, what do we get? A single-day 490-point jump for the Dow Jones Industrial Average yesterday—its biggest one-day gain in years!

All of a sudden, the Dow Jones Industrial Average is up over 12,000 again, this bear market rally is up close to seven percent for 2011 including dividends, and it looks like the stock market will end 2012 where I predicted it would (see Stock Market: Where it Will End 2011).

Yesterday, six world central banks (including the Federal Reserve and the Bank of Canada) cut the interest rate at which banks can borrow U.S. dollars. Hence, the cost for European banks to borrow the greenback has dropped significantly from the three-year high it stood at the day before.

Dear reader, I don’t pretend to be the smartest analyst or economist in the world. In fact, I’ll be the first to admit that I don’t think I fully understand the effects of the announcement of the six central banks yesterday. But I do believe it has something to do with either printing more money or expanding the money supply again, as I see gold bullion is up $40.00 anounce since the news came out that these six central banks would reduce the interest rate at which banks can borrow the greenback.

For the benefit of our new readers, a bear market rally’s purpose is to lure investors back into the stock market. A Phase I bear market started in October of 2007 and brought stocks down to 6,400 on the Dow Jones Industrial Average on March 9, 2009. On that date, a Phase II bear market, often called a bear market rally, started.

That bear market rally has been going on for months due to the U.S. government’s bailout of Wall Street and the financial system and the Federal Reserve’s massive expansion of the money supply. The government and Fed are fighting the bear tooth and nail…and that’s why this bear market rally has lasted so long. A bear market rally ends when investors have reached the point where they believe the stock market is a safe place to invest again—we’re not there yet; too much pessimism reigns. A Phase III bear market, the final phase, tends to bring stocks back to their original lows reached at the end of the Phase I bear market.

Michael’s Personal Notes:

My fellow financial editor, Robert Appel, BA, BBL, LLB, sent the below e-mail alert yesterday. I feel it important to share with my Profit Confidential family of readers:

“As we move into the last month of the year, we want readers to know that, on a balance of probabilities, December should perform and put some cash in our pockets. While there are no guarantees—indeed, catastrophe looms daily in world events—these are our reasons why we believe December will be a good month for investors:

“The stock market had started to rally in the fall and was derailed by Europe. However, one often hears that the stock market, like a horse, ‘prefers to move in the direction it was already headed.’ Since the European Union must (repeat MUST) define their solutions in December (holiday or no holiday), we would expect further strengthening, not weakening, assuming the EU can maintain a united front (itself a big supposition, of course).

“Secondly, the bankers (who most of us just found, to our shock and horror, really do rule the world—and make the politicians jump to their commands, it seems) traditionally need a strong December/January to move money around, mop up unused pension funds, and clean up balance sheets. And then pay themselves their typically outrageous year-end bonuses. So they are motivated.

“Thirdly, as for the mining sector, we have noticed that the ‘gold whackers’ like to play both sides of the fence. That is, even though the gold whackers make most of their cash by shorting for their clandestine ‘clients,’ every now and then, they will mix it up by going long after a big short, then ‘standing aside’ to let gold’s natural momentum move it up, taking their profits, and starting shorting anew at higher levels. We think this could be the pattern in December.

“Finally, by now everyone and their brother understands that, at current gold bullion prices, the gold mining stocks are trading at valuations (depending on which chartist you listen to) between 10- and 30-year lows. When the common wisdom actually reaches the common people, usually paradigms will finally shift. The chance to load up on the gold miners at bargain prices is coming to an end, we think.”

(Also see: 10-year Strategy of Buying Stocks When Gold Bullion Moves Lower in Price Still Working)

Where the Market Stands; Where it’s Headed:

Yesterday, if you read the popular media, you’d think yesterday’s huge, single-day, 490-point jump for the Dow Jones Industrial Average has everything to do with the six central banks saying they cut the interest rate at which banks can borrow U.S. dollars. I’m not so sure this is the reason.

A big concern for investors, governments and economists these days is the slowing Chinese economy. China, an economy that has been growing at 10% per annum for years, the foreign country that buys the majority of the U.S. Treasuries, the country that Europe went to, to ask for a bailout, is seeing its economy slowing. And this is instilling the fear that the world economy will start to slow.

Yesterday, the Chinese government reduced the amount of cash that banks must set aside as reserves to make loans—the first time it has done so since 2008! This move will increase credit in China and help the Chinese economy immensely.

We continue to be in a bear market rally that started in March 2009.

Michael’s Personal Notes:

“I see the coming recession being deep and difficult because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that, when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.