Some old-time market watchers are still calling for Great Depression II. One research report I read earlier this week by a well-known economist says we are in a depression.

I’m in the enviable position of being one of the few analysts who called the severity of this recession back in the beginning of 2007, before the word “recession” was even on the lips of the majority of economists.

Back on November 15, 2006, on these pages I wrote, “The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” On January 31, 2010, I wrote, “The hard facts about the real estate market in the U.S. are truly scary. How can the U.S. economy escape the hard landing in U.S. home prices? As we’ll soon find out, it simply can’t!”

A week later I said, “1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.”

But I’ve always predicted a severe recession, never a depression. And here’s why I continue to believe that:

Ten thousand American banks failed during the Great Depression. Many depositors lost their money. By the time this recession is over, 1,000 banks in the U.S. will have failed. The FDIC covers the money depositors have in banks to the tune of $250,000 per depositor per institution. There was no FDIC insurance in 1932.

The stock market had been rising for the majority of the 1920s until the crash of 1929. If we look at the chart of the S&P 500 stock index (which is not as easy to manipulate as the Dow Jones Industrials, with stocks being cherry-picked in and out of the Dow Jones), the S&P 500 stock index has been down for over a decade.

In the 1920s, you could have bought stocks with 90% margin (only 10% of your money). For years now, you’ve needed at least 50% up front to buy a stock and stocks have to be preapproved for margin.

During the Great Depression, the official rate of unemployment in the U.S. surpassed 20%. This morning, the U.S. Labor Department reported that the August unemployment rate was 9.6%.

The inflation rate during 1932 was negative 10%. We do not have a negative inflation rate today.

The one aspect of the economy that has hurt us more in this recession compared to the Great Depression is the housing market. During the Great Depression, the average price of a home in the U.S. fell 15% from peak to trough. This time, from their ridiculous peak in 2005, U.S. home prices have fallen 30%. Compounding this problem is the fact that a much greater portion of the population owned a home in 2005 than in 1932. The government is combating this problem with interest rates that are low, a program to help people restructure their mortgages, and a home-buying incentive program, which recently expired (and which I wouldn’t be surprised to see come to market again).

As I wrote a couple of days ago, the black clouds in the economy are dissipating ever so lightly. But make no mistake; they are dissipating. In my life as an investor, I’ve always made money buying investments when others have feared to do so (the old “buy low, sell high” adage). For those who are more concerned about us entering a depression as opposed to us exiting a severe recession, they are missing a huge buying opportunity.

Where the Market Stands:

Trading range? Yes, that’s what analysts have been calling it; we are stuck in a trading range. The Dow Jones Industrial Average has been trading in the range of 11,000 on the upside and 9,750 on the downside since May of this year.

Two things about trading ranges: 1) eventually they are broken (either through the upside or downside); and 2) you can still make good money on stocks during a trading range.

With 30-day U.S. Treasuries yielding a pathetic 0.12% and the five-year Treasury at 1.43%, the dividend yield on the Dow Jones Industrial stocks of 2.7% is an attractive alternative for investors. Hence, I do not see stocks as overvalued.

Until proven wrong by the stock market, I continue to see stocks in a bear market rally that started in March 2009.

The Dow Jones Industrial Average opens this morning down one percent for 2010, but up 60.2% since March 9, 2009.

What He Said:

“For the economy, the message from retail stocks is quite clear: consumer spending, which accounts for roughly 70% of U.S. GDP, is in jeopardy. After having spent like “drunkards” during the real estate boom years, consumer spending is taking the same trend as housing prices, slowing down faster than most analysts and economists had predicted. As news of the recession continues to make headlines in the popular media, the psychological spending mood of consumers will continue to deteriorate, lowering earnings at most high-end retailers and bringing their stock prices down even further.” Michael Lombardi in PROFIT CONFIDENTIAL, January 28, 2008. According to the Dow Jones Retail Index, retail stocks fell 39% from January 2008 through November 2008.

U.S. banks posted their biggest profit in three years for the quarter ended June 30, 2010. According to the FDIC, U.S. banks earned $21.6 billion in the second quarter of 2010.

So, the improving economy is bringing bank profits back up again. When you add in the $18.0 billion in profits these banks had in their first quarter, we are looking at a profit for U.S. banks of about $40.0 billion in the first half of this year.

But, despite the banks starting to lay on the profits again, they continue to tighten the lending standards. In the second quarter, net loan and lease balances for U.S. banks declined $95.7 billion.

Hence, instead of the banks lending out money to get the economy going, they are lending less. Sure, I’ve heard bank presidents say that consumers and businesses are not borrowing. But I also know of many businesses that cannot get loans, because they cannot meet the stricter requirements. You cannot compare the lax lending rules of 2005-2007 to the rules of today — there is a huge difference.

Banks have an obligation to their shareholders to make money. After all, it is the shareholders’ money that is at risk. Thus, to ask banks to make lending easier, with the risk of loan losses increasing, is not fair. That’s like asking my business to lower the cost of our publications to make them more affordable to all, but that would risk the viability of the business and the people who work in it.

In this economy, on one side, you have the consumers/businesses that need money, but can’t get it, because lending requirements have become stricter. On the other side, you have the consumers/businesses that don’t need the money and are not borrowing (even though they qualify), because they are concerned about spending/growing in today’s weak economy. That’s why they call it a recession.

Yes, economic conditions are improving. But until confidence levels return — the confidence for banks to lend more aggressively, the confidence for consumers to borrow to spend again, and the confidence for businesses to invest in plants, equipment and marketing again — the black clouds over this economy will only disperse ever so lightly.

Michael’s Personal Notes:

I’m getting really tired of the media (mostly financial commentators) bashing President Obama. Let’s get real; he is our President. Bashing our President is shameful.

I am not tied to either political party. I have read good arguments on how President Clinton started the economic mess with his policies that pushed for increased home ownership in America. I have read good arguments on how President Bush’s Administration spurred the economic havoc by not providing enough financial industry oversight.

Whenever I write about politics, I get the most e-mails back with reader opinions. It is obviously a very sensitive topic. I’m not going to individually blame the Administrations of Clinton or Bush (although maybe collectively they should be blamed), but I do know that President Obama walked right into this mess.

President Obama, along with a Federal Reserve Chairman who has studied the Great Depression’s causes and effects, is doing the best he can with what he knows. We all have personal opinions: I’m not a believer in making the government larger to cure a recession; I think the damage to the economy would have been less significant if Lehman Brothers was saved; and I’m disappointed that small business in America wasn’t helped during the recession.

But would I bash and smear a President, the highest elected office of this country? Never. We need to face the reality that we have never had, and will never have, a President with a deep, experienced understanding of the stock market and the economy. The lack of this doesn’t mean that the media has the right to bash the President continuously.

Where the Market Stands:

The Dow Jones Industrial Average starts this first day of September down four percent for 2010. Most advisories I read (that are not published by us) are negative on the stock market. Most popular business magazines are starting to carry articles on the “double dip” recession. Negativity is strong. In this type of environment, the market usually surprises on the upside.

Hence, I’m maintaining my opinion that we are in a bear market rally. This opinion has served me well over the past 19 months and, until I see corporate earnings decline or the main stock market averages move decisively lower, I remain positive on the bear market rally.

What He Said:

“Prepare for the worst economic period ahead that we have seen in years, my dear reader, as that is what I see coming. I have written over the past three years how, in the late 1920s, real estate prices fell first before the stock market and how I felt that the same would happen this time. Home prices in the U.S. peaked in 2005 and started falling in 2006. The stock market is following suit here in 2008. Is a depression coming? No. How about a severe deflationary recession? Yes!” Michael Lombardi in PROFIT CONFIDENTIAL, January 21, 2008. Michael started talking about and predicting the economic catastrophe we started experiencing in 2008 long before anyone else.

Years ago, we published an investment report on how Alan Greenspan and the government had a secret plan to devalue the U.S. dollar to make the ever-rising national debt of the U.S. more palatable. Was it really a secret plan?

I’ll never know. But if we look at the policies of President Obama’s administration and the current Fed chairman, coupled with the fact that selling U.S. Treasuries has never been so easy, one has to say that this “plan” is being played out quite well.

The government itself says that our national debt is $13.0 trillion, headed to $20.0 trillion by the end of this decade. I read one report yesterday that pegs our off-balance sheet debt (debt not on the books of the U.S. government), which includes old-age security, welfare, pension benefits for government employees, and other future government obligations, at over $100 trillion.

U.S. Treasuries are flying off the shelf, and we are very lucky as a country that we do not have to pay onerous interest charges on the debt we are issuing. In fact, people buying U.S. T-bills are basically not receiving a return at all, if you can call 0.15% on a three-month T-bill a return on investment. Investors are flocking to U.S. Treasuries for security purposes…they know the U.S. government will pay them back.

A chart of the U.S. dollar compared to a basket of the world’s most popular currencies tells the true story. The U.S. dollar has been declining for years against other world currencies.

So, the fool foreigners financing our debt through the purchase of U.S. Treasuries are not only receiving meager interest payments on their money, but they are also seeing less capital coming back when these T-bills mature, as the U.S. dollar keeps declining in value against most other world currencies.

Hence, the secret plan is working very well. We’re piling on debt to save and jump start the economy, knowing that, in the years ahead, as investors eventually shun U.S. Treasuries, our debt obligations will be “easier” and less costly to actually repay.

Here’s an example:

A Canadian institution bought U.S. T-bills several years ago, when it cost $1.20 Canadian to buy one U.S. dollar. Today, when that T-bill matures, the Canadian institution only gets back $1.04 U.S. per Canadian dollar invested, because the Canadian dollar has risen in value (like most currencies) against the U.S. dollar through the years. Regardless of whether this is planned or not, it’s very smart on the part of our government.

Every country wants a cheaper currency, because it makes debt repayments more palatable while lowering the cost of exports, the latter being something domestic manufacturers welcome with open arms. The U.S. is winning “the war of the declining currency.”

But, as the U.S. dollar continues to fall against other world currencies, only one currency is really benefiting, and that currency is not a fiat currency like the yen, yuan, or euro. That currency is gold.

The writing is on the wall: raise as much money as possible to finance our debt, and drop the value of the U.S. dollar to make those debt repayments “cheaper.” Gold benefits under such a scenario, because gold is sold principally in U.S. dollars. Is it any wonder the gold mining stocks are the only stocks rising these days?

Michael’s Personal Comments:

Investors are waking up this morning to a Dow Jones Industrial Average below the 10,000 level for the first time in weeks. Out of the last six trading sessions, the Dow Jones has been down five of them.

But it’s not just the stock market that has been getting whacked this week. Most commodities are down or flat, the U.S. dollar has taken a beating, and everyone is running to the safety of U.S. Treasuries.

Remember that old song with the lyric, “only fools rush in,” made famous by Elvis? Welcome to the U.S. bond market of 2010 — where fools are rushing in. I would not be a buyer of bonds at this point in the economic cycle. All bubbles burst, and the bond market is not exempt to bubbles.

The stock market is severely oversold and due for a bounce.

Where the Market Stands:

The Dow Jones Industrial Average opens his morning down four percent for 2010. I continue to believe that stocks are trading in the confines of a bear market rally.

The halfway point between the Dow Jones’ multi-year low on March 9, 2009, and its subsequent high earlier this year is approximately 8,850. Hence, for those readers who have written asking when I would consider the bear market rally over, technically speaking, the rally that started in March 2009 will not be over until 8,850 on the Dow Jones is decisively broken.

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 in PROFIT CONFIDENTIAL, January 10, 2008. WCI Communities, the largest U.S. luxury homebuilder, filed for Chapter 11 protection on August 4, 2008.

There is a bubble forming in today’s economy and I believe that bubble is in U.S. Treasuries. Yesterday, the yield on 10-year Treasuries fell to 2.5% for the first time since 2009.

Why the big rush to U.S. T-bills?

A one-word answer explains the situation: fear. The fear is that the anemic U.S. housing market will not recover, and thus the U.S. economy will lapse back into recession.

Despite the rate on a standard 30-year mortgage sitting at only 4.53%, according to the National Association of Realtors, purchases of existing homes fell 27.2% in July 2010 from the previous month. And that has fear setting back into the stock market.

But I see the fear as opportunity. Here’s why:

The popular S&P/Case-Shiller 20-City Index says that U.S. home prices fell 33% from mid-2006 to April of this year. This is the biggest decline in home prices in the U.S. on record. To give you an idea of the magnitude of the fall in prices, during the Great Depression, home prices fell only 15% in the U.S.

With the housing market backtracking, the S&P 500 has hit a five-week low, with the popular stock index’s price/earnings multiple falling to 14, matching the price/earnings ratio of the Dow Jones Industrial Average for the first time in weeks.

I see the decline in the U.S. home price market and the fear surrounding a further price decline in housing as an opportunity for investors to buy at bargain basement prices. Yes, home prices in the U.S. have fallen during this recession by more than double the rate they fell during the Great Depression; but remember unemployment during the Great Depression hit 25%. Today, unemployment in the U.S. is less than half that, at 10%.

Further, during the Great Depression, about 10,000 banks went under in the U.S. The Great Recession that started in 2008 is expected to claim 1,000 U.S. bank failures before the economic contraction we are experiencing is over — and depositors at those banks will have their deposits protected by the FDIC.

Only a few short decades ago, the U.S. government created the Resolution Trust Corporation to deal with all real estate U.S. thrifts and savings institutions foreclosed on, as oil prices crashed in 1986 to about $10.00 a barrel level. I remember those days very clearly.

No one wanted to buy U.S. real estate in the later part of the 1980s because no one believed real estate prices would ever come back. Boy, were the great majority of investors wrong. The smart money made a fortune in the late 1980s buying foreclosed-upon real estate from the banks and RTC. I see that opportunity again today for risk-takers.

This year, U.S. banks will foreclose on about one million homes in the U.S. The “smart” money is buying foreclosed real estate, as property prices continue to be depressed across America. Meanwhile, the “scared” money is chasing U.S. Treasuries for meager returns.

Who do you think will be the big winners in the end?

Michael’s Personal Comments:

Ever hear of a fellow named Douglas Yearly Jr.? Didn’t think you did.

Douglas is the CEO of Toll Brothers, likely the largest builder of luxury homes in the U.S., with an average price per home in excess of $500,000. Toll, which has been around for over 40 years, lost over $1.0 billion since the U.S. recession started.

But, even with U.S. homebuilder confidence at its lowest level on record, Yearly is buying land at dirt cheap prices…and plenty of it. Since January 2010, Toll Brothers has invested 250 million dollars in land acquisitions at bargain basement prices.

I believe that time will prove Yearly to have been a very smart fellow.

Where the Stock Market Stands:

The Dow Jones Industrial Average starts this morning down 3.7% for 2010. Above, I talked about the fear gripping the stock market these days.

While I’m long-term bearish on the general economy (due to too much government debt, a falling U.S. dollar, the U.S. Treasury bubble, and higher interest rates ahead), I have yet to see evidence that the bear market rally that started in March 2009 is over.

Yes, the rally has stalled for several months now, but the rally has not reversed or ended.

What He Said:

“In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” Michael Lombardi in PROFIT CONFIDENTIAL, January 10, 2008. The year 2008 ended up being one of the worst years for the stock market since the 1930s.

At the beginning of this year, some analysts were predicting that U.S. interest rates would rise in the later part of 2010, early 2011. Those forecasts have simply been put on hold because the U.S. economy is recovering at a much lower growth rate than previously predicted.

I read one report this weekend from a well-known economist who believes that the Fed will not be able to raise interest rates until 2012. I see that as too far out. By 2012, U.S. government debt will be about $15.0 trillion. I doubt that investors will keep buying those T-bills at today’s current reduced interest rates as U.S. debt balloons.

My personal opinion is that we should not be so cocky in expecting interest rates to be low for the next two years.

Look at these five important economic realities:

Interest rates are low in the Fed’s effort to get the economy going, accelerate job growth and help the anemic housing market. Low interest is also a bonus for a government saddled with record debt, like the U.S. is today.

But interest rates being low have a negative impact on the economy as well. A Federal Funds Rate of zero is artificial. The low-interest-rate, easy-money policy we have today tempers inflation. Because of economic uncertainty, especially following the Greek crisis of this spring, investors have been flocking to the U.S. dollar for safety. This will not last forever.

Eventually, as more debt is piled on by the government, the U.S. dollar will come under immense pressure against other world currencies. A lower valued U.S. dollar is ideal for us, but a dollar falling too rapidly could push foreigners away from the greenback, and the only way to stop that is via higher interest rates.

As the economy improves, large U.S. corporations, which are not borrowing right now, will re-enter the market with corporate debt. This will put U.S. Treasuries in competition with quality U.S. corporate bonds, pushing up interest rates, as more debt competes for the same takers.

Finally, why isn’t the U.S. stock market higher today than it is? The dividend yield on stocks is close to three percent and the yield on five-year Treasuries is less than half of that.

The yield on the popular 10-year U.S. Treasury is close to the dividend yield on stocks today. Could the stock market and the bond market both be wrong at the same time (stocks predicting higher interest rates ahead, long-term bond market predicting slower economic growth for years to come)?

Investors shouldn’t take today’s low-interest-rate environment for granted. Similarly, they should not expect these low rates to last for years. Interest rates will surprise on the upside quicker than the majority of today’s analyst and economists expect.

Yes, Japan needed to keep its interest rates low (near zero) for more than a decade, and there have been many comparisons of Japan’s “lost decade” to today’s fragile U.S. economy. But the yen was not the reserve currency of 70% of all central banks. And that makes a world of a difference.

Michael’s Personal Notes:

According to RealtyTrac Inc., lenders foreclosed on 92,858 U.S. homes in July, up nine percent from June and up six percent from July 2009. RealtyTrac expects over one million homes in the U.S. to be lost to foreclosure this year.

The above is obviously bad news. But, as I have been writing in these pages, the fall in U.S. home prices has tapered off. Prices have stopped falling, but obviously prices are not rising either, given the glut of foreclosed properties on the market.

The number of U.S. homeowners receiving their first default notice fell sharply in July, down 28% from July 2009. This is good news.

Good deals in the U.S. real estate market abound. But if you are planning to take the dive, for investment or vacation purposes, you will have to hold that property for years before you start to see any price appreciation.

Where the Market Stands:

The Dow Jones Industrial Average starts this week down two percent for 2010.

With the Dow Jones price/earnings multiple at 14 and the dividend yield at 2.7%, when compared to three-month U.S. Treasuries yielding 0.15% or five-year U.S. Treasuries yielding only 1.44%, I do not see stocks as expensive at this time.

I continue to believe that the bear market rally that started in March of 2009 is alive and well.

What He Said:

“When I look around today, I see falling stock prices…I see falling house prices…and prices falling for retail goods stores declining. The media has it all wrong blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively as deflation starts to rear its ugly head.” Michael Lombardi in PROFIT CONFIDENTIAL, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst bout of deflation since the Great Depression.

I had the pleasure this week of reading General Motors’ preliminary prospectus, all 542 pages of it. The GM public offering will be the second largest initial public offering (IP0) in U.S. history, second only to Visa’s public offering of March 2008.

In my own mind (which is the best way for me to phrase it), here’s how I see the GM story.

GM mismanaged its business. I’m not chastising them; it could happen to any business that’s grown too big. Demand for cars was strong, products kept coming off the production line, customers bought them and, with profits rolling in, in its wisdom GM management decided not to worry or plan for the possible bad times ahead.

GM got into big financial problems as the recession of 2008 and 2009 descended, so they went to the government and asked for money. GM received about $50.0 billion from the U.S. government and top-up money from the Canadian government. The money came in the form of loans and equity. The loans were paid back, but the U.S. government was left owning 61% of GM.

How about all those investors who owned GM stock who couldn’t sell it because the stock was falling so fast, before the company filed for bankruptcy? Well, you know how it goes; the public be damned.

The U.S. government decided to bail out GM, a private company. I don’t see where in the U.S. Constitution says that government can bail out private companies, but it happened. The government wanted to rescue thousands of GM jobs; it wanted to keep the U.S. automotive industry afloat. Although I cannot prove it, I’m sure the idea of keeping blue-collar voters happy was present somewhere in their thinking.

My question is this: why did the government bail out GM while thousands of small businesses across this country went bankrupt, because the government decided not to help them, the backbone of the U.S. economy? Sixty percent to 70% of all U.S. jobs come from small businesses, but the government didn’t help them. The public be damned again.

Now, GM will go public at an anticipated offering of $16.0 billion. I’m sure the government wants this done, because it will take the U.S. government from being the majority owner of GM to the minority owner. The government can say, “Look, we invested money in GM to save it, and we are getting our money out. We didn’t lose anything; we saved American jobs.”

And, as for Wall Street — it just gets rich again. Wall Street brokers made money putting investors’ money into the original GM, because they made brokerage and underwriting fees selling stock. Now, with GM going public again, Wall Street looks forward to repeating huge profits one more time. The way I read the prospectus, Morgan Stanley and J.P. Morgan are the lead brokers, followed by the usual characters: Goldman Sachs, Merrill Lynch, Barclays, Citigroup, et al. Millions and millions of dollars in underwriting fees will now go to these companies.

As for the public, well, you know how it goes: someone always buys the stock that The Street peddles.

Michael’s Personal Notes:

Summer 2010 is fast coming to a close. Kids are getting ready to go back to school. Parents are busy making arrangements to get them organized for that first day. Luckily, so far this year, we’ve missed the hurricanes that traditionally play havoc with the south in late summer.

And, with summer just about over, we realize we are only five months away from Christmas. Most of my friends have already made plans for their Christmas/New Year’s vacations. As crazy as it sounds, some popular spots for the “well-heeled” are already full for the coming winter vacation season.

The stock market crash of 2008 and 2009? The housing crash of 2007 to 2009? While it is a reality for thousands of Americans who continue to suffer because of the Great Recession, unless you worked for Bear Sterns or Lehman Brothers, the Wall Street crowd is doing well again.

Profits at the big brokerage houses are up sharply and I wouldn’t be surprised to see the return of Wall Street’s big Christmas bonuses this year. The other day, a colleague of mine summarized what happened on Wall Street from 2002 to 2009. “They got drunk on their own money, got bailed out by the government when it was hangover time and, having recovered, they are slowly starting to drink again, setting the stage for the next big party.”

Where the Market Stands:

The stock market, as measured by the Dow Jones Industrial Average, opens this morning down 1.5% for 2010. Stocks are basically where they started the week.

I’ve written a few articles now comparing the dividend yield on stocks to the yield on U.S. Treasuries. (You can see those figures daily on our web site at www.profitconfidential.com.) I continue to believe that investment money does not have many places to turn to these days. Investment money is not going into real estate or gold (at least not yet, in the case of gold).

Short-term treasury yields opened this morning at multi-month lows indicating that investors are still running to U.S. T-bills. I believe that the dividend yields on stocks today offer good support and value for the stock market. And my opinion that we are in bear market rally that started in March of last year remains.

What He Said:

“Even the most novice investor can now read the chart of the Dow Jones U.S. Home Construction Index and see that it is trading at its lowest level in five years. If, like me, you believe that stocks are an indication of what lies ahead, this important index is telling us that housing prices are headed to 2002 levels! What would that do to the economy? Such an event would devastate the U.S.” Michael Lombardi in PROFIT CONFIDENTIAL, December 4, 2007. Michael was one of the few analysts who called the severity of the U.S. housing market collapse.

Investment money has a tendency to run to the place where it has the potential for the highest return.

In the late 1990s, we saw investment money run into tech stocks as the NASDAQ hit 5,000 (only at 2,209 today, 10 years later). In the mid-2000s, we saw money run to real estate as property prices boomed on interest rates that were low and easy-lending policies (residential property prices have fallen about 30% since then).

When the Great Recession hit, “money” got scared and ran to the safety of U.S. Treasuries. But with so much money chasing T-bills, bond yields fell to their lowest rate of return on record. Money isn’t running to gold yet, because most investors have yet to realize there is a bull market in gold bullion prices (but this will eventually happen, propelling gold prices much higher than they are today).

By our estimates, the stocks that make up the Dow Jones Industrial Average will collectively pay $280.00 in dividends this year. Based on yesterday’s close, the Dow Jones Industrial Average is yielding 2.7%.

Compare the 2.7% dividend yield of the Dow Jones Industrial Average to the three-month U.S. T-bill yield of 0.15%, or the three-year U.S. T-bill yield of 0.77%, or even the five-year U.S. T-bill yield of only 1.42%, and suddenly stocks do not look expensive.

Historically, bull markets have ended when the dividend yield on stocks has fallen below three percent and bear markets have ended when stock dividend yields have hit six percent. However, we must realize and acknowledge that these old guidelines were based on normal interest rates. A Federal Funds Rate of zero and 30-day Treasury rate of 0.15% are far from normal.

If we look specifically to return on money, stocks today, based on dividend yields alone, offer investors the biggest bang for their buck. As the U.S. economy continues to improve, as we understand that high unemployment and low residential housing prices are here to stay for years, and the fear of such turns into acceptance of “the way it is,” the yields on stocks will look more and more attractive.

Stock market advisors in 2010, several of whom are calling for stocks to crash, are failing to look at the various returns on money investors have available to them. Stock dividends yields today, compared to the yields on other forms of investment, are offering support and value for stock prices.

Michael’s Personal Notes:

The second quarter of this year marked a very significant point in world economic history: in the second quarter, China surpassed Japan as the world’s second largest economy.

China’s gross domestic product in the second quarter of 2010 came in at $1.34 trillion. U.S. GDP is about $3.5 trillion a quarter. China was already the world’s largest automobile market and the world’s biggest exporter.

A report from Price Waterhouse Coopers says that China will take over from the U.S. as the world’s largest economy by the year 2020. Goldman Sachs believes will happen in 2027.

But does the timing really mean anything? No. The fact is that we will see the U.S. dethroned as the world’s biggest economy in the short years ahead. For almost a decade now, I have been writing about the importance of investor portfolio exposure to the growth in China. It’s not too late to seriously consider diversifying your portfolio to ensure you participate and benefit from the unprecedented growth in China.

Where the Market Stands:

Yesterday, the Dow Jones Industrial Average turned just about breakeven for 2010. The market is in a narrow trading range. While most of the old big-name advisors are very bearish on stocks, I continue to believe that we are in a bear market rally that started in March 2009 and that the rally still has more time to run.

What He Said:

“The Dow Jones Industrial Average, the S&P 500 and the other major stock market indices finished yesterday with the best two-day showing since 2002. I’m looking at the market rally of the past two days as a classic stock market bear trap. As the economy gets closer to contraction, 2008 will likely be a most challenging economic year for Americans.” Michael Lombardi in PROFIT CONFIDENTIAL, November 29, 2007. The Dow Jones Industrial peaked at 14,279 in October 2007. A “suckers” rally developed in November 2007 which Michael quickly classified as bear trap for his readers. By mid-November 2008, the Dow Jones Industrial Average was at 8,726.

I think I finally get it.

With the U.S. government set to issue an additional $1.2 trillion in U.S. Treasuries this year to help finance its budget deficit and with many economists saying that our total national debt is out of control, the U.S. government is paying very little in terms of interest on its ballooning debt.

Because big U.S. corporations are still worried about the economy, they are sitting on a hoard of cash. Depending on what report you read and believe, the S&P 500 companies are sitting on just over $2.0 trillion in cash and have slashed their borrowing.

The mood of U.S consumers has also changed. Instead of being borrowers, they are becoming savers. I thought I would never see the day when Americans stopped spending and started saving, but that day is here.

In September 2005, I wrote in these pages of how the U.S. savings rate had reached zero. Throw in one heck of a recession, and what happens? Americans stop spending and start saving. I’m pleased to see that the U.S. savings rate is above six percent today.

But if U.S. companies are sitting on big cash and not borrowing, and American consumers are saving and not spending, who is borrowing money? The U.S. government, of course.

Hence, lack of demand for loans from banks and consumers has pushed rates on Treasuries down to record lows. And our government is taking advantage of interest rates that are low to finance the big deficit it has created to jump start the economy.

Last week, the U.S. government sold about $30.0 trillion in three- year Treasuries at an interest rate of only 0.84%. Yields on 10-year Treasuries are now well below three percent.

I guess if was running Washington, I’d think we need to create jobs to get Americans back to work; we cannot risk a double-dip recession. And, with interest rates so ridiculously low, let’s borrow to our hearts’ content to get this economy going again. And I think that’s exactly what is happening.

But all good things need to come to an end. The piper eventually needs to be paid. Will it be rapid inflation that eventually pushes interest rates back up? Will it be a devaluing U.S. dollar that will push rates up? Or will the economy simply improve to the point that businesses start borrowing again, thus pushing interest rates up?

Right now, income investors, with the trillions of dollars sitting in bond and fixed income funds, have little choice but to buy U.S.
Treasuries. Big demand for Treasuries continues to push interest rates on those treasuries down.

How will this all end?

We are sailing into waters we have never been before.
Unfortunately, I do not believe that the story of the U.S. government issuing huge amounts of debt at interest rates that are ridiculously low will end well at all.

Michael’s Personal Notes:

Below, we’ve started to add to PROFIT CONFIDENTIAL our estimate on what the stocks that make up the Dow Jones 30 Industrial companies will earn this year, what price/earnings multiple those earnings will translate into, and the dividend yield. We then relate those numbers to the stock market’s current price level. You can check these numbers daily now at www.profitconfidential.com.

Where the Market Stands:

Here are this week’s opening numbers:

— We expect the Dow companies to earn a total of $740.00 per share this year (total earnings per share for the 30 stocks).
— Translated price/earnings ratio is under 14. Dividend yield is 2.7%.

The Dow Jones Industrial Average opens this morning at 10,303.15, down 1.2% for 2010. I see the market continuing the bear market rally that started on March 9, 2009.

At a dividend yield of 2.7%, and given that 30 U.S. T-bills pay only 0.15%, the market is far from overpriced. The bellwether 10-year treasury only pays 2.66%.

What He Said:

“Any way you look at it; the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second, and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in PROFIT CONFIDENTIAL, August 27, 2007. “As for the stock market, it continues along its merry way, oblivious to what is happening to homebuyers’ wealth. [Since 2005, I have been writing about how the real estate bust would be bigger than the boom.] In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed.
History has a way of repeating itself.” Michael Lombardi in PROFIT CONFIDENTIAL, November 21, 2007. Dire predictions that came true.

This morning, the U.S. Commerce Department reported that U.S. retailers saw a 0.4% increase in July sales, the first increase after two months of downward sales. Most of the gains came from auto sales.

Given that the summer months are a relatively slow period for retailers (“back to school” buying doesn’t really start until late August, early September), the increase in retail sales, although anemic, is on track for an economy coming out of a severe recession.

Retailer Dillard’s, Inc. (NYSE/DDS) reported this morning that its second-quarter income turned positive from a loss in the same period one year ago, with net sales up 2.7% for Dillard’s. J. C. Penny Company, Inc. (NYSE/JCP) also returned to a profit in the second quarter, from a loss in the same period in 2009.

Unfortunately, the Dow Jones U.S. General Retailers Stock Index doesn’t share the sales turnaround at the retailers. After topping at 380 in April of this year, this index is down 17% to 314 today. Why the sharp decline in retail stock prices, and, more importantly, are they a buy now?

There are still many deep-rooted problems with economy; the biggest for retailers being the unemployment rate. With millions of Americans out of work, retail sales will remain flat. The uncertainty about the “Recession Double Dip” has instilled a cautious attitude in other shoppers. And of course it doesn’t help that American retailers have trained consumers to shop at “big savings event” sales.

Let’s face it; for cheap, lower-end retailers, unless you are Wal-Mart, it will difficult to make money, as consumers continue to hold back, product margins are reduced, and competition is fierce.

In this sector, I like the high-end retailers. Look at the price chart of Coach, Inc. (NYSE/COH), a high-end retailer of women’s purses and shoes. The stock is up 39% from a year ago, and has become a favorite among investors, because the brand is so strong.

Would you rather own the stock of a company that sells $50.00 purses or $300.00 purses? If the $300.00 purse is in big demand, because it is a recognized brand and delivers a fashion statement, this would be the way to go.

Now, if only one could buy a stock that directly reflected the profit of the “Louis Vuitton” brand…that would be one great stock to own.

Michael’s Personal Notes:

The Labor Department reported today that U.S. consumer prices rose 0.3% in July, the biggest gain since 2009. The core rate of inflation, which excludes food and energy prices, rose 0.1% in July.

While economists tend to focus on the core rate of inflation, I like to look at the overall rate, as food and energy are things that consumers need, things they have to pay for, thus excluding them doesn’t represent a family’s true increase in cost of living.

Many of my associates have been writing about the fear of deflation. Inya Ivkovic wrote a great article on these pages this past Wednesday comparing the deflationary “lost decade” of Japan to where the U.S. may be headed today.

I believe that deflation was a problem in 2005-2007. Since then, the housing market busted and the stock market dropped to a 12-year low (March 200), thus the worst of deflation may be behind us. I’m more concerned with inflation.

The amount of U.S. dollars in the system, the amount of U.S. debt, zero interest rates, and the Federal Reserve now starting to buy government debt: for me, that is cause for fear of inflation. As the U.S. dollar continues its downward spiral against other world currencies, will it not require more dollars to buy goods, thus pushing up inflation?

Gold, known throughout the world as an inflation hedge, is at an all-time price high. We need to ask ourselves an important question: would gold be rising if deflation was in the cards? If we want to look at the Japanese case, during Japan’s “lost decade,” gold in Japan did not rise in value.

Where the Market Stands:

It’s been a choppy past couple of days for the stock market, but I’m sticking with the belief that we continue to operate in the confines of a bear market rally. The Dow Jones Industrial Average starts today down one percent for 2010.

What He Said:

“I personally expect the next couple of years to be terrible for U.S. housing sales, foreclosures and the construction market. These events will dampen the U.S economic picture significantly in the months ahead, leading to the recession I am predicting for the U.S. economy later this year.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2007. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.

Wherever I travel in the U.S. these days, I see business picking up. There is less discussion about the possibility of a double-dip recession. The businesses that did survive the recession are slowly turning the corner.

The banks, while they may not be lending to small business, are posting strong profits. The tech companies, from Apple to Google, and it seems everything in between, continue to roll out the profits. Even the industrial companies are coming back. And, yes, the car companies are making money again.

But we are left with many serious problems in the economy. The jobless rate is high, national debt is out of control, and the economy continues to move so pathetically along that the Fed cannot raise interest rates.

It is becoming more and more apparent to me, as the days and years pass, that the U.S. is following the route of the old European countries. With our manufacturing base all but gone, the U.S. is slowly joining the ranks of European countries that saw their factories fade so many years ago.

Fewer jobs. Higher debt. The poor stay poor. The rich get richer. The middle class slowly deteriorates. Government gets bigger. That seems to be the fate of the United States.

I travel to Europe each year and I see America’s future. The talk of Great Depression II persists with some people in the U.S., especially those without jobs and those who lived through the Great Depression. But something more profound, something life-changing that will change the way the U.S. operates in the decades ahead is happening.

The great American dream of opening a business up to manufacture a product, like the widget business we were taught about in that economic class we took in high school, has passed future American generations by. We have moved from being a country that manufactures goods to becoming a service-oriented economy, very similar to so many European countries like Great Britain, Italy, and France.

And, with that, the U.S. has gone from being a creditor nation (a country that is owed money) to a debtor nation (a country that owes money to other countries) all in less than 50 years. The future does not look good for America.

But it is important for investors like us to remember that the major old countries of Europe still offer profit opportunities to investors. Investor opportunities do not disappear as an economy goes from being a producer of goods to a provider of services. They are just fewer and further between.

Michael’s Personal Notes:

The most common question this past July to me: “Michael, is it too late to buy into gold?”

There is a simple answer to that question, because I have answered it so many times before: It was not too late to get into gold when it was $600.00 an ounce and people were asking the same question. It was not too late to get into gold when it hit $1,000 an ounce. And, in my opinion, it is not too late to get into gold at $1,200 an ounce.

For those who say that gold is at a speculative top, that deflation will ravage gold, I strongly disagree. In my many years of studying market trends, I have never seen a chart look as beautiful as a gold price chart from 2002. The rise in gold prices, I remind the pundits, has been a slow, steady rise. Not a rise to match the NASDAQ euphoria of 1999 or the housing market of 2005.

Markets do not top when the majority of investors do not realize it is a bull market. And that is the present case with gold. Of the many investment newsletters we sell, our gold-stock-picking newsletter is the hardest sell. This experience tells me that the majority of retail investors do not believe in the gold bull market.

In 1999, with our NASDAQ stock-picking newsletter, we couldn’t print copies fast enough for investors. The opposite is true for our gold-stock-picking newsletter today. Investors do not want advice on picking gold stocks. This is a strong indication to me that the retail investor is out of the gold market — that means this gold bull market has a long, long way to go.

I’m sure when gold hits $1,500 an ounce, I will be asked the same question: “Michael, is it too late to buy gold?”

Where the Market Stands:

The Dow Jones Industrial Average opens this week up 2.2% for the year. In my opinion, the bear market rally that started in March 2009, while getting tired, continues.\

What He Said:

“Starting two years ago, I was writing how the housing boom would go bust and cause the U.S. economy to suffer sharply. That’s exactly what is happening today. From what I see happening in the U.S. economy, I’m keeping with the prediction I made earlier this year: By late 2007/early 2008, the U.S. will be in a homemade recession. Hence, I expect housing prices to continue declining, soft auto sales, soft consumer spending, and a lower stock market.” Michael Lombardi in PROFIT CONFIDENTIAL, August 15, 2007. You would have been hard-pressed to find another analyst predicting a U.S. recession in the summer of 2007. At the time, the stock market was roaring, with the Dow Jones Industrial Average hitting its all-time high of 14,164 in October 2007.

There is no doubt in my mind that the real estate market has bottomed out. I’m in Miami this week trying to pick up some “deals” in this recession-hit-hard town and I’m starting to see some changes in the marketplace for real estate.

I want my dear readers to be aware of two important changes in the property market:

— While there is still a glut of property (condos and vacation properties) on the market, prices have stopped declining because foreign buyers are in the marketplace buying up the deals. Florida and Arizona, in my circle of associates, are the places real estate investors are buying in.

— The bank-foreclosed deals and properties about to go into foreclosure (also known as “short sales”) are being bought by investors with cash. No financing. When you see cash buyers that usually signifies patient money that believes now this the time to buy. Cash buyers often do not have the pressure to sell. When cash buyers come in, it is usually a signal of a bottom in any market.

In Florida, the more inland you go (away from the ocean), the more prices for real estate have dropped. It is common to find inland property selling at half the price it sold at during the property market peak in 2005. There is a glut of product and cranes still stick through the top of unfinished condo buildings.

But, slowly, these depressed properties are being taken up by investors (or people looking for vacation homes) who are taking the “I might never see prices like this again” attitude.

While I’ve given my readers two important positives for the real estate market in the U.S., if you are planning to jump into this market, I also want to give you three warnings:

— A great number of homes in the U.S. (that have not been foreclosed on yet) are worth less than their mortgage. At any point, these homeowners might cave in and walk from their homes. That would put more product on the market, softening prices again.

— Interest rates cannot stay low forever. Once the Fed starts to tighten, which the majority of economists believe will happen in late 2010 or into 2011 (barring an inflation surge), real estate prices will come under pressure. In general, property prices rise when interest rates fall, and property prices fall when interest rates rise.

Yes, the bottom might be in for property prices in the U.S. But, because of huge inventory overhanging the market, prices may stay at the same level they are today for many years to come. So, if you are looking to make that real estate investment today because of depressed prices, you will need the patience to wait several years before those prices move back up again. As the old adage goes, “Patience is friend of the investor, enemy of the speculator.”

Michael’s Personal Notes:
Are the car-makers coming back to life?

Ford, GM and Toyota are all obviously doing better now that the recession is over. But how about the side effects of the recession, like the high unemployment rate — will that not keep consumers
away from buying cars?

Toyota, the world’s largest automaker, reported its biggest quarterly profit in two years yesterday. The company also hiked its sales forecast for 2010 to 7.38 million cars. Ford and GM sales are on the upswing, too. Rumors of a GM public offering persist.

Make no mistake about it, the economy is fragile. While demand is slowly rising for the car-makers, companies like GM, Ford and Chrysler are not as bloated as they used to be. By “bloated,” I mean they have closed dealerships to concentrate on only the most profitable sales locations, slashed overhead, and cut employees and employee costs. They are more efficient.

In the years ahead, as the economy continues to improve, the automakers will do better. But I wouldn’t personally be a buyer of the GM public offering, because the overhang of stock owned by the government could cause resistance on the stock price if the government decides to sell its stock into the market.

Ford stock has been a good play. But remember that looming higher interest rates could be another big problem for the automakers.

Liking the auto stocks, but not enough to buy them yet.

Where the Market Stands:

The Dow Jones Industrial Average opens this morning up two percent for 2010. After some seesawing in June and July, the bear market rally that began in March 2009 is back on the upward swing.

The economy is doing better, the stock market is moving higher — maybe retail investors (the majority of which missed this current market advance) will start getting back into the stock market. The bear would like nothing more than that.

Enjoy the rally and remember, “The trend is your friend.” We are up in the stock market for 2010 again, so that trend is “up” for now.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure — these are the bank stocks I wouldn’t own.” Michael Lombardi in PROFIT CONFIDENTIAL, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.

“I’ve been writing to my readers for the past two years claiming that the decline in the U.S. property market would not be the soft landing most analysts were expecting, rather a hard landing. My view remains unchanged. The U.S. housing bust will be cut deeper and harder than most can realize today.” Michael Lombardi in PROFIT CONFIDENTIAL, June 13, 2007. While the popular media was predicting a bottoming of the real estate market in 2007 Michael was preparing his readers for worse times ahead.

With the first half of 2010 behind us, here’s an update on where I see things headed for the remainder of 2010, and where I believe my readers can make some money:

Stocks:

The surprise in stocks for the immediate term is on the upside. People are still very worried about the economy. National debt is out of control. Employment is high. Retail investors are staying away from the stock market. But corporate earnings are beating analyst expectations.

If you were to ask me about the short term, which would include 2011, I would tell you I am very bearish. I’m bearish because our dollar cannot sustain its value on the great amount of debt we have accumulated. National debt of $20.0 trillion by the end of this decade (we’re at over $12.0 trillion today) will place immense pressure on the U.S. dollar, which will eventually result in higher interest rates.

Higher interest rates may also be required as a deterrent to rapid inflation, which has historically been a problem for America after a prolonged period of easy money. But, for the months ahead, the Fed cannot raise rates because the economy is fragile. A low-interest-rate environment combined with rising corporate earnings is what the stock market loves. So I’m bullish for the immediate term, bearish going into 2011.

Like I’ve said all along, the bear market rally will suck more investors in before its next leg downward. And the best way to suck investors in is to move the market higher so investors feel that all is well again.

Gold:

I bought more gold last week, because I believe we are getting close to a bottom for the traditionally soft summer months for gold prices. If gold moves closer to $1,100 U.S. an ounce, I will buy more.

Because of my fears about the ramifications of ballooning U.S. debt, the concern about inflation and the longer-term worry about the status of the U.S. dollar as the world’s reserve currency, gold looks like an ideal investment to me for the years ahead. As absurd as it sounds, I’m expecting gold in the $2,000-to-$3,000-per-ounce range as time passes.

Real Estate:

The period 2009 to 2011 will go down as the bottom for real estate prices in the U.S. Banks and sellers have caved in to accepting “what the market is” and are thus accepting the lower prices they would not accept in 2007 and 2008.

I’m visiting Florida this week to see where I can come up with some bargains. The states that got hit the hardest by the real estate crash (Florida, Nevada, pockets of California and Arizona) offer the best values. Just because prices have bottomed for real estate, don’t expect them to rise for years. But remember: in real estate investing, money is made on the buying, not the selling. What this means is that buying at depressed prices is most important.

The Economy:

The people from small- and medium-sized business I speak to are telling me that the demand for their products and services is slowly starting to come back. Through the innovation of America’s businessmen and businesswomen, costs have been cut, ingenuity is prevailing, and the “machine” is starting to work again.

Please don’t get me wrong. Many businesses are still having trouble. Our manufacturing base has been eroded for good. But most businesspeople will tell you that 2010 is looking better than 2008 or 2009. The light at the end of the tunnel is getting brighter, but, unfortunately, it has been at the cost of lost American jobs. Profits are returning more as an outcome of slashed costs rather than rising revenues.

What He Said:

“Overbuilt, 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 began talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.

On a recent trip to Manhattan, on Fifth Avenue near Central Park, I saw a retail window with the following written in huge yellow letters, “Smart Has the Brains, But Stupid Has the Guts.” My daughter took a picture of this store front window and I’ve kept it in my cell phone picture memory since.

Why am I telling you this?

Over the past 10-year bull market in gold bullion prices, each time the market corrects, the naysayers come out and say, “The bull market in gold is over.” And each time they are wrong.

Have you noticed all the articles in the business pages of the newspapers and the Internet the past month on how deflation could become a big problem? Well, the gold naysayers love this type of media. The economy is improving as well and the U.S. dollar looks like a haven every time another world currency comes under pressure.

So, who would be stupid enough to jump more deeply into gold given the above points? Me.

As I’ve watched and participated in the gold bullion rally since late 2002, each time I see gold prices move lower, I see a buying opportunity. We all know that the summer months (based on seasonality price charts) are the worst time for gold bullion prices.

Gold bullion prices peaked at about $1,260 an ounce in late June of this year. Since then, the metal has fallen back about $100.00 an ounce to the $1,160-an-ounce level. Looking at a price chart, the metal could fall even further to $1,100 an ounce, but why take the chance and wait for even lower prices that may never even materialize? I’m not.

Gold has risen steadily in price from $300.00 an ounce in late 2002 to $1,260 last month, a gain of 320% in eight years. Just as higher than the previous December 31 for nine straight years now. This gold bull market is very strong.

The rise in gold prices could foreshadow a time down the road (could be a year, could be five years) when inflationary pressure will rise substantially and/or the debt of the U.S. will become a huge obstacle for the value of the U.S. dollar, undermining its status as a
world reserve currency.

This past Friday, the White House raised it forecast for the fiscal 2011 budget deficit to $1.4 trillion. Over the next 10 years, Washington is projecting additional debt of $8.5 trillion. We already have $12.0 trillion in debt, so we are headed for $20.0 trillion in
national debt. How can any currency, backed by such debt, sustain itself?

That’s why the “guts” buy more gold.

Michael’s Personal Notes:

The Obama Administration is finally doing something for small business, but I believe the program is ill conceived…that the money will not flow through to the small businesses that are the backbone of this economy.

Under a bill that is awaiting Senate approval, the government will move $30.0 billion to small community banks. The hope is that the banks will leverage that money and offer $300 billion in loans to small businesses, which the government hopes will lead to new jobs. While the intent is good, I do not see this program working.

Talk to any small business banker today and they will tell you the same story: “There is a lack of demand from creditworthy customers” and “The biggest demand for small business loans is from the least creditworthy customers.”

Putting money in small banks to make loans is a great idea — but the government cannot force banks to make loans it believes are risky. In the first half of 2010, Bank of America, the biggest bank in the U.S., wrote off a staggering 14% of small business loans…10 times the rate of other commercial loans.

After the recession, banks are looking for more equity and profitability from small businesses before lending them money, and that is the real reason small businesses cannot get loans. Small business loans that would have qualified for some form of government guarantees (reducing the risk at the banks so they make more loans) would have been a more viable plan.

Where the Market Stands:

As I predicted in a mid-July editorial, “Stock Markets Getting Reading to Turn Positive for 2010,” the market abided and turned positive earlier this week. For 2010, the Dow Jones Industrial Average is up 1.1%.

It has been difficult for a market student and commentator like me to remain positive on the bear market rally in the face of the large head-and-shoulders pattern the Dow Jones formed in the first half of this year and in light of continued poor economic news. Each time the market moves lower, more stock market advisors come out and call the rally over.

But I’m sticking with my gut feeling that the bear market rally that started in March 2009 is not over…that the bear will continue its rally in an effort to suck more investors into the market before taking that big second leg down.

According to a recent survey from the American Association of Individual Investors, the number of individual investors who are bearish on the stock market has hit the highest level since July 2009…and we all know what has happened to stock prices since then.

The stock market does not decline when investors expect it to…and that’s why I believe the bear market rally will continue in the immediate term.

What He Said:

“Over the past few weeks, I’ve written about subprime lenders and how their demise will hurt the U.S. housing market, the economy and the stock market. There’s no escaping the carnage headed our way, because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom that peaked in 2005, have yet to arrive.” Michael Lombardi in PROFIT CONFIDENTIAL, March 22, 2007. At the same time Michael wrote this, former Fed Chief Alan Greenspan was quoted as saying: “…the worst is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”

A common question I’ve been hearing over the past couple of months is, “Michael, if you believe the stock market will ultimately retest its March 2009 low, why are you recommending positions in gold stocks. After all, if the stock market falls, won’t gold stocks fall as well?”

Yes, this is true. If the stock market goes down, all stocks will be affected. But my bet is that gold stocks will be the least affected by a downturn and they can actually be a good place to park cash.

I say this for three reasons:

Junior gold mining companies have not performed well since the bear market rally started in March 2009. There are many bargains amongst the junior gold mines right now. As the price of gold moves towards $2,000 an ounce, the juniors will rise in price — they are a great speculative play.

The majority of companies listed on the stock market have their success somehow related to consumer demand. After all, the American economy is 70% consumer-driven. Companies like Apple Inc. (NASDAQ/AAPL) could see their earnings drop quickly if consumers stop spending. Gold companies are not affected by consumer spending patterns.

Only two factors drive the price of a gold stock, and that is how much gold the company has access to and the price of that gold. As the stock market declines, money will move out of stocks and into…what? T-bills paying less than one-percent interest? Real estate you can’t liquidate once you buy it? Investors will run to quality gold stocks.

Homestake Mining and Dome Mines (comparable to Barrick Gold and Newmont Mines of today) were the two biggest gold mining producers in the early 1930s, when the Great Depression hit. These stocks did exceptionally well during the 1930s.

A stock price chart of the Dow Jones Industrial Average from the early 1920s to the late 1930s looks terrible…millions of investors lost billions of dollars. But look at a chart during the same period of U.S. gold mining companies and you will see a strong trend upwards.

So, bottom line: all stocks go down during a bear market. But gold stocks, at least during the 1930s, outperformed the popular stock market average exponentially. In fact, U.S. gold stocks were one of the best places to park cash in the 1930s, as these stocks more than tripled in price during the decade, while the rest of the stock market collapsed.

Michael’s Personal Notes:

I really can’t write enough about the terrific job Steve Jobs has done over at Apple Inc. We are talking about a fellow who started the company, was pushed out by his own board of directors, had health issues, got a liver transplant, and overcame so many obstacles. It’s a perfect example, I remind my children regularly, of what persistence and determination can lead to.

Yesterday, Apple reported a huge 76% profit in third-quarter profit. Net income in Apple’s last quarter hit $3.25 billion. Call it demand for the new “iPad,” demand for the latest version of the “iPhone” or simply customer spending on the upswing, Apple continues on a tear.

Jobs has not created a business; he has created a culture. And this is why Apple exceeds. It doesn’t matter if you already have an “iPhone.” If an updated version comes along, you want it, because you love the brand so much. A culture, a community, is much stronger than a business.

Is it any wonder why Apple stock sells at $250.00?

Where the Market Stands:

The Dow Jones Industrial Average opens this morning down 1.9% for 2010 and only 200 points away from turning positive again for the year.

I read so many negative stories about the trading volume being light on the market, the technical picture for stocks being very poor, the economy still in shambles…I often write about these topics myself. Yes, the long-term outlook for America is negative.

But, right now, the stock market — or should I say the bear market — only looks six to 12 months out. With all the negativity surrounding the market and with corporate earnings continuing to rise, I still believe that the bear market rally will continue riding the wall of

worry before it moves lower.

What He Said:

“I see a deal when it’s a deal. And right now there’s a good ‘for sale’ sign flashing on gold bullion and gold producer shares. In fact, after peaking at the $690.00 an ounce level earlier this year, gold could be a bargain at its current price of around $650.00 per ounce. As a

reader, you are undoubtedly aware of my negative stance on the general stock market and the U.S. economy. As the economic problems continue to brew in the U.S., as these problems develop into others, and as they are finally exposed, what other investment but gold will worldwide investors turn to?” Michael Lombardi in PROFIT CONFIDENTIAL, March 14, 2007. Gold bullion was trading at under $300.00 an ounce when Michael first started recommending gold-related investments. Many gold stocks recommended in Michael’s advisories gained in excess of 100%.

07/19/10 — Money was flowing on Wall Street last week. Add up the second-quarter profits of Intel (NASDAQ/INTC), Google Inc. (NASDAQ/GOOG), Bank of America Corporation (NYSE/BAC), JPMorgan Chase & Co (NYSE/JPM), Citigroup, Inc. (NYSE/C) and General Electric Company (NYSE/C) — which all reported their second-quarter profits last week — and you have $18.4 billion in earnings hitting the Street.

One would think it was time to rejoice! After all, corporate profits are on a roll again. But the market has been concerned with something else, something more serious for future earnings.

As we all know, on Thursday, Congress passed the most comprehensive financial reform since the Great Depression. Most financial institutions have publicly commented that the bill, which is over 2,000 pages, will have an impact on their future earnings. Unfortunately, the financial institutions have yet to figure out the exact financial impact of the new bill. Most banks are “still trying to figure it out.” And if there is something the stock market does not like, it is uncertainty.

The Goldman Sachs Group, Inc. (NYSE/GS) has agreed to pay the SEC 550 million dollars to settle its civil fraud suit. The penalty, the largest amount ever paid by a financial institution to the SEC, comes amid rumors that the SEC might lay other charges against Goldman
for more possible securities regulation breaches.

Hence, when you add the Goldman Sachs settlement and the unknown cost to financial institutions of the new financial reform bill, money is being taken away form the Street, not added.

Looking at the charts, the Dow Jones U.S. Bank Index is down 64% from its peak in early 2007. Comparatively, the Dow Jones Industrial Average is only down 24% over the same period.

We all know that the bursting of the real estate bubble hit U.S. banks hard. Now, through the new financial reform bill and hefty SEC fines, the government is giving big American banks a “you should have known better” slap in the face.

Would I jump into the financial stocks?

Despite the great earnings being generated by companies like Bank of America, Citigroup, and JP Morgan, I believe that the stock market is telling us these companies are far from out of the woods.

We need more information on how the financial reform bill will affect the U.S. bank stocks before making the decision to jump in and buy them.

Michael’s Personal Notes:

Yes, it is true. Effective January 1, 2012, all U.S. sales and purchases of gold and silver coin of $600.00 or more in value will have to be reported by the transacting dealer to the IRS.
Source: www.numismaster.com.

Where the Market Stands:

The Dow Jones Industrial Average opens this morning down 3.3% for 2010. I’m still of the opinion that we are in bear market rally that will take stocks higher first, before the next leg of the bear takes hold.

What He Said:

“There is no mixed signal about this: Foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously consider unloading their stocks of consumer-products companies that produce
nonessential goods.” Michael Lombardi in PROFIT CONFIDENTIAL, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.

Mark this number down: 10,428.05. That is the closing value of the Dow Jones Industrial Average on December 31, 2009. I expect the market to soon turn positive for 2010, moving the Dow Jones above its 2009 close of 10,428.05.

Why will the bear market bring stocks back into positive territory for 2010?

The “head and shoulders” pattern that the stock market completed forming in late June of this year was likely the most well publicized stock pattern in years. Many analysts and advisors turned bearish on the stock market following the formation of the right shoulder of the head and shoulders pattern.

Yes, technically speaking there has been a lot of damage to the stock market. If the Dow Jones Industrial Average ever gets above its 2010 high of 11,258, it will be quite a feat.

If there is one thing I have learned after a lifetime of studying the market, stocks rarely do what is expected of them. If the majority of stocks analysts and advisors are expecting the market to fall (as was the case earlier this month), the stock market will not bow down and oblige.

When pessimism reigns, the market moves higher.

The bear market in stocks, which started in late 2007, has only one objective: Bring as many investors as possible back into the stock market before taking stock prices down again.

We’ve witnessed the first leg of the bear market, as the Dow Jones Industrial Average fell from 14,164 in October 2007 to 6,440 on March 9, 2009. From there, when investors were exhausted and most pessimistic, the bear moved stocks back to 11,258 in April of this year.

There is no doubt that the second leg of the bear market will soon start. But it will be on the bear market’s own timetable and own terms. The retail investor took the pain of the drop in stock prices from October 2007 to March 2009, but retail investors in general were missing from the picture as the bear rally took stocks up almost 5,000 points on the Dow Jones from March 2009 to April 2010.

Before the second leg of this bear market takes its first step, I believe that the bear will do its best to lure investors back into the stock market. That’s why I called for Dow Jones 10,000 late in 2009, and later for Dow Jones 11,000 in 2010. And that’s why I believe the market will soon turn positive again for 2010.

Michael’s Personal Notes:

The technical definition of a recession is two down quarters of GDP. In the U.S., in late 2008 and into 2009, we had three consecutive down quarters of GDP. Loyal readers will remember that I called the recession in 2007.

The U.S. has now experienced three quarters of positive GDP, the most recent GDP report being a positive 2.7% for the quarter ended March 31, 2010. Most economists have forecast positive GDP for the quarter ended June 30, 2010 (not yet released by the Commerce Department).

Hence, and technically speaking, the U.S. has endured the most damaging recession since post World War II. But the effects of the recession and the fear of a double-dip recession are far from over.

Unemployment in the U.S. is still around 10%, banks are not lending to small businesses like they used to, and our annual deficit and national debt are at record levels. The housing market is still a bust, with millions of American homeowners living in homes that are worth less than the mortgage on them. May 2010 was the worst month on record for the sale of new homes in the U.S. Thirty million Americans are receiving food stamps, and one in five American children live below the poverty line.

Recession technically over? Yes. But we are far from out of the woods on this one.

What He Said:

“If I had to pick one stock exchange that would rank as the best performer of 2007, it would be the TSX (Canada’s equivalent of the NYSE). Interest rates in Canada remain very low and they are not expected to rise anytime soon. Americans looking to diversify their portfolios, both as a hedge against the U.S. dollar and a play on gold bullion’s price rise, should consider the TSX. Most brokers in the U.S. can buy stock on this exchange.” Michael Lombardi in PROFIT CONFIDENTIAL, February 8, 2007. The TSX was one of the top performing stock markets in 2007, up just under 20% for the year.

07/12/10 — Here’s the most common question that arises whenever I bump into a PROFIT CONFIDENTIAL reader: “Michael, how close are we to really having another Great Depression?”

This is a question best answered by the facts:

During the 1930s, approximately 9,000 banks in the U.S. failed and there was no FDIC insurance for depositors. Comparatively, after the FDIC shut down four banks last week, the total number of banks to fail in the U.S. this year has now hit 90.

The most pessimistic predictions are for 1,000 total bank failures in the U.S. because of the recession that started in 2007. The FDIC covers up to $250,000 per depositor per institution if a bank fails. Again this protection was not present during the Great Depression.

Unemployment in the U.S. hit 25% during the Great Depression. Today, unemployment sits around 10% and worst-case predictions are for that rate to go to 12%.

In the 1930s, in a huge government mistake, the “Smoot-Hawley Tariff Act” was passed to restrict trade with foreign countries. Today, the U.S. is a heavy promoter of international trade.

Leading up to the stock market crash of 1929, stock brokerage houses would lend you $9.00 for every $1.00 you had invested with the stock brokerage house in stocks, or a 90% margin. Of course, today margin accounts can only give you a 50% margin; for every $1.00 you have invested in a stock, you can get another $1.00 as a loan. And not all stocks are marginal.

Finally, there are mixed views on how the Federal Reserve acted during the Great Depression years. Economist Milton Friedman believed that the government was contracting the money supply at a time it should have been expanding the money supply. Of course, today, we have a very expansive monetary policy, with interest rates at record lows.

So back to the question:

Can a second Great Depression happen? Sure, anything can happen at any time. But if we look at the points above, we are very far away from Great Depression II. The recession we experienced in 2007 can be solely attributed to the decline in the value of U.S. real estate that
started in 2005.

Falling house prices led to failed mortgages, which led to failed mortgage-backed securities, which led to investment bank failures and mortgage company failures, which led to declining stock prices.

We need to give to give credit to Ben Bernanke and the U.S. Federal Reserve. They have done a masterful job at steering us away from the Great Depression II. We just need to see the long-term effects of how all that debt we accumulated trying to save the economy works out.

Michael’s Personal Notes:

“So where have you been, Michael?” From the e-mails and phone calls, it seems my loyal readers missed me last week. Thank you. It’s nice to be missed.

I’ve been travelling in the U.S., trying to get a handle on how our economy is faring. Reading the right newspapers and economic news stories on the Internet gets you a “feel” for how the economy is doing. But to get a real feel, you need to be in the trenches talking to big and small businesses about how things are going for them.

While I will talk about the findings of my travels in my next few commentaries, I did come back with a more upbeat feeling about the economy and our future. There is no doubt in my mind that the real estate market is dead and will be dead for the next couple of years at
a minimum.

But small and mid-sized businesses, in general, are witnessing an uptick in the demand for their products and services. While banks are still not lending like they used to, innovative American business people are climbing out of their rut. This is great news for our
economy.

At the end of the first quarter of this year, non-financial companies in the U.S. were sitting on $1.84 trillion in cash, according to the Federal Reserve. As a percentage of total assets, cash on corporate balance sheets is at its highest level in about 40 years. Such a high amount of cash on company balance sheets tells me three things: First, corporate America is playing it very cautious. They want to see how the economy fares in the months ahead before investing in plants, equipment, and inventory. Second, corporate America has the cash to spend as the economy improves. Third, if the economy does not improve, corporate America has the cash to work through a double-dip recession.

Cash is king in poor economic times. Corporate American has figured that out this time around.

Where the Market Stands:

The Dow Jones Industrial Average is set to open this morning down 2.2% for 2010. We’ve passed mid-year, and big-cap stocks have gone nowhere in 2010.

If we look at the fundamentals, as I have written above, there is no doubt that the economy has improved since late 2008. The risks are still there (sovereign debt in European countries and at home, the pathetic American real estate market, a slowing Chinese economy), but corporate earnings have been improving and there is nothing that the stock market loves more than rising corporate earnings.

On the technical side, a chart of the S&P 500 looks like a “dog’s breakfast.” A huge top is in for most stock market indices. When the right shoulder of a head and shoulders pattern has been formed, it is the kiss of death.

The most positive thing I think the market has going for it is the great number of pessimists out there. I have failed to see a stock market newsletter or advisory service that has not mentioned the big negative around the head and shoulders formation. You know how I feel about the market. It always does the reverse of what is expected of it. As long as so many advisors and analysts are bearish, the market has support.

What He Said:
“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour wait…people are spending in America today at an unbelievable clip. 1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi, in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.

— “Profit Confidential” Column, by Michael Lombardi, CFP, MBA

Tiffany & Co., the luxury retailer, announced this morning that it made 140 million dollars in profit in its fourth quarter, up from 30 million dollars a year ago.

Looks like the rich are back at buying luxury items again after a big scare in 2008. Or is retail in general that is picking up?

Also this morning, Williams-Sonoma, what I would call a mid-market retailer, announced it made 88 million dollars in its fourth quarter, up from only 12 million dollars in the same period of 2008.

So what gives with retail? Are consumers starting to buy again?

With retail companies, it is tricky to see what is really happening, because a retailer can often improve earnings by working its inventory, closing stores, firing staff, etc. What is important to economists is if retail sales in general are rising. And, in the case of both Tiffany and Williams-Sonoma, their sales rose 17% and 8.1%, respectively, in the fourth quarter.

Consumers are definitely spending again, led by luxury items.

It is extremely important to note that the Dow Jones U.S. Retail Stock Index is only 12% away from breaking its high of 2007. There are few other sectors that can make this call except hot sectors like gold mining.

Did investors dump retail stocks too quickly going into the recession? The answer is more than likely, yes. The chart of the Dow Jones U.S. Retail Stock Index looks well positioned to break above its 2007 high. And I wouldn’t be surprised to see that happen before the bear market rally in stocks is over.

Michael’s Personal Notes:

You haven’t heard much from me lately, as I just got back this weekend from a one-week trip in Europe. I’ll be writing plenty about my trip in upcoming editions of PROFIT CONFIDENTIAL. But, if there was one take-home message for me it was twofold:

The economic crisis of 2008 hit Europe much harder than it hit the United States. Secondly, I am convinced, more than ever, that the euro will not become an alternative currency to the U.S. dollar.

Yes, I believe the U.S. dollar will lose its status as the world’s reserve currency, but it will not be replaced by the euro.

Where the Market Stands:

The Dow Jones Industrial Average opens this week up three percent for the year. Having spent the weekend reading stock and economic research reports, it is surprising to see how many analysts are presenting arguments for why the stock market shouldn’t go up. In my experience, when that happens, stocks just ride the wall of worry higher.

Making stock market predictions can get analysts like me in trouble if we are wrong simply because we lose credibility. I was one of the few to predict that the Dow Jones would surpass the 10,000 level (I said this when the Dow Jones was under 9,000) and I am probably the only one out there predicting that the Dow Jones will pass through the 11,000 level.

The bear market rally that started in March of 2009 is alive and well.

What He Said:

“When I look around today, I see falling stock prices…I see falling house prices…and prices falling for retail goods stores declining. The media has it all wrong blaming (worrying about) inflation. In my opinion, the single biggest threat to the U.S. economy and to the Fed in 2008 is deflation. You can bet the Fed will expand the money supply and drop interest rates aggressively as deflation starts to rear its ugly head.” Michael Lombardi in PROFIT CONFIDENTIAL, December 17, 2007. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.

— “Profit Confidential” Column, by Michael Lombardi, CFP, MBA

We made it.

The bear market rally that started in March of 2009 brought stocks to a new post-crash high yesterday. The Dow Jones Industrial Average opens this morning at its highest level since October 2008 and only 111.17 points away from my prediction of Dow Jones 11,000.

How did we get here?

We got here (to a new 18-month stock market high) because companies slashed payrolls, slashed spending, took advantage of interest rates that were low and started focusing back on their core businesses.

Let’s face it, the economic boom years that ended in 2006-2007 resulted in many companies acquiring companies they shouldn’t have, companies opening new divisions, hiring people they didn’t need, getting involved in businesses they knew nothing about.

I remember being at a cocktail party in New York in 2006 and a lady trying to explain to me what she did at a large financial institution that just hired her. From my knowledge of her, she knew nothing about finance. And, for the life of me, after listening to her for an hour, I still couldn’t figure out what her job was.

And, of course, the stock market would not be moving higher if the Fed was keeping interest rates at historically low levels. Forget the fear following the market lows of March 2009. History has proven that whenever the Federal Reserve drops interest rates aggressively, a higher stock market follows 12 to 18 months later.

For my fellow stock market analysts, I have this to say:

The trend is your friend. Always has been. Always will be. Don’t lose sight of this.

I read three research reports this past weekend from well-known stock market advisors that all predicted the market was going to crash. But, here we are mid-week and the market has moved to a new 18-month high.

Yes, we all know the U.S. dollar is headed for the toilet. Some of us know hyper-inflation follows extended periods of zero interest rates. I’m in the camp that believes the Fed is being too slow at raising rates again to cool the stock market. And I still believe the stock market lows of March 2009 will be tested.

But the bear market doesn’t work in days or weeks; its plan evolves over months. The bear market is working exactly as I predicted it would: bring the stock market higher after the initial down leg (that ended in March 2009), so investors believe the worst is behind us, lure as many investors back into the stock market, and then move the market down to the next leg, which is usually lower than the first.

For my dear readers:

As I have been saying since March 2009, enjoy this bear market rally while it lasts. If you followed my advice and jumped into stocks in March 2009 and have held on, you are doing just fine. There is more money on the table for you for now.

Michael’s Personal Notes:

Yesterday, after the Dow Jones rallied 103 points, reporters were quick to credit a France, Germany and IMF aid package for Greece as the reason the market rallied. Nothing could be further from the truth. Yesterday was a classic bear market rally to lure investors back into stocks. I don’t believe the stock market could care less about Greece’s problems. After all, isn’t the U.S. just as financially broke as Greece?

There was no doubt in my mind that fellow European Community countries would help Greece with its debt problems. I have written about this before. Germany’s Angela Merkel wants the IMF to bail out Greece. France’s Nicolas Sarkozy wants a “European solution.” In the end, they will do what they need to do to save face with their euro.

Where the Stock Market Stands:

The Dow Jones Industrial Average sits 4.4% higher this morning than when it started 2009. There is not much else I can say about the stock market that I haven’t already said in my lead story above.

What He Said:

“In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: Borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” Michael Lombardi in PROFIT CONFIDENTIAL, January 10, 2008. The year 2008 ended up being one of the worst years for the stock market since the 1930s.