No doubt this is an equity market that wants to go higher. The market is due for a correction; it just experienced a small consolidation; but no matter what the economic analysis, institutional investors are buying. They are buyers right now because the earnings outlook is great, interest rates are low, and there isn’t anything else to invest in that has above-average return potential.

The S&P 500 Index seems to have broken through the 1,300 level, which has been a barrier for a while (though it could still retreat). With the number of earnings preannouncements low, 1,500 seems to me like a cakewalk for the index. My money is on rising stock prices, not the other way around.

The good news is that, even at 1,500, the S&P 500 Index won’t be expensively priced. I would say it would be fairly valued and this bodes well for the rest of the year. As we’ve seen recently, the economic data aren’t uniform. Revised fourth-quarter gross domestic product numbers were solid, yet February orders for durable goods were below expectations. I think this mixed trend in economic news will be with us for quite a while. I don’t see us having runaway economic growth anytime soon and, while things may be slow at the Main Street level, Wall Street will continue to bet on a brighter future. The present doesn’t matter on Wall Street—only the past and the future.

Stock picking in this market is also a choppy affair and, just like with the economic news of the day, some companies are doing better than others. It’s difficult to imagine an across-the-board acceleration in business conditions. As an investor, you really need a basket of special situation stocks in order to beat the market.

As we’ve been saying consistently for a number of years now, investing in gold remains a good idea, even if you’re a new investor. A number of smaller gold mining companies recently saw their stock prices accelerate significantly after reporting excellent financial growth in the fourth quarter. While the returns might be incremental, as so many gold stocks have already gone up, there is still plenty of good trading action in this sector if you like to speculate in gold shares. I still wouldn’t have a balanced equity portfolio without holding at least one gold producer. Global capital markets continue to be behind gold not only as an investment, but increasingly, as a store of value over some currencies as well.

The best stock picker I follow, Jim Rogers, figures that a correction is probable in stocks and commodities. But he always adds that, when it happens, it will be a good buying opportunity. He figures the commodity price cycle has another 15 years or more to play out.

The key in China will be the rapid growth of the country’s middle class. In a recent research finding, Credit Suisse predicted that the household wealth in China will double to $35.0 trillion by around 2015 based on achieving sustainable GDP growth at or near the current growth rate.

The economic analysis is simple. The extra Renminbi means more cash to spend on non-essential goods and services. This includes furniture, real estate, vehicles, and travel.

I have been a big supporter of the Chinese auto sector.

You don’t have to tell General Motors Company (NYSE/GM) to go to China and look for growth opportunities. In fact, you don’t have to tell anyone.

Going out and buying GM would not be my best stock advice, but that is not to say that there are not other opportunities to play the Chinese auto market.

The world’s automakers know that, to grow, you need a presence in China’s auto sector, whether in it’s a venture with a Chinese company or as a standalone manufacturer of vehicles. The auto sector in China remains strong, as the country is the world’s largest auto market, with an estimated 16.5 million vehicles sold in 2010, according to the Chinese Industry Association.

Sales are showing some signs of slowing early in 2011. In the January-February period, vehicle sales were 10% year-over-year to 3.15 million vehicles in China, down from 84% growth a year earlier. While this is a concern, the absolute sales growth in China is still staggering.

General Motors, a rising player in China, reported a 34% year-over-year rise in its February sales to 184,498 vehicles. While good, this was well below the record 268,071 sold in January. GM and its Chinese partners sold 2.35 million vehicles in 2010, well above its U.S. sales.

Yes, there is clearly some slowing in the Chinese auto market, but I view dips as opportunities to buy for those with a longer-term view.

Given that only about 41 in 1,000 Chinese own vehicles, according to some industry pundits, there is clearly ample room for growth, especially as the income levels continue to rise. This fact will drive vehicle sales going forward to the point where China will likely remain the top auto market in the world.

The area of expensive or luxury vehicles is booming in China. The middle class is growing at a staggering pace, with more millionaires being created. When consumers find wealth, a big-ticket item they buy is a vehicle. The richer they become, the more they spend on vehicles. The sale of luxury cars is surging in China, according to auto industry researcher J.D. Power and Associates. The rate is well above what we are seeing in other industrialized countries.

There are numerous ways to play the Chinese auto sector. You can buy an auto company with exposure to China, such as the major global automakers.

Alternatively, you can also buy Chinese auto-parts makers. Some Chinese auto plays that I have covered in the past include Brilliance China Automotive Holdings (OTCBB/BCAHY.PK), China Automotive Systems, Inc. (NASDAQ/CAAS), Wonder Auto Technology, Inc. (NASDAQ/WATG), SORL Auto Parts, Inc. (NASDAQ/SORL), and AutoChina International Limited (NASDAQ/AUTC).

It’s difficult thinking about stocks, commodities and investing in general when you see the tremendous devastation in Japan. Stock picking seems like a flippant endeavor compared to dealing with the loss of life in this natural disaster. My cousin’s husband is a Japanese American executive with Coca-Cola in Tokyo. Their immediate family is all right, but, as they communicated over e-mail, the entire country is virtually shut down.

The markets are clearly reflecting the shock of it all, as well as the very real economic worries now affecting the globe’s third largest economy. Japan consumes a lot of the world’s exports and there will no doubt be an immediate adjustment to businesses selling product to that country. As Japan’s economic interests naturally turn inward to focus on recovery and restoring infrastructure, the country’s fiscal situation will no doubt worsen. All this, just when Japan’s economy was seemingly coming out of a long period of stagnation.

Domestic lumber stocks are slightly ticking higher as speculators bet on Japan’s new infrastructure requirements. This, of course, is mostly just trading noise at this point. It’s way too early for any economic analysis of Japan’s actual need, other than it is enormous. This kind of speculation is just as likely not to work out anyway. Japan may choose to rebuild with metal studs instead of spruce. I don’t even want to think about it.

From a purely financial point of view, my analysis of domestic capital markets is that they will withstand this natural disaster. The stock market is now in the “lull” between earnings seasons and is actually holding up well considering the severity of events. The stock market has been due for a correction and it seems like events in Japan are unfortunately the catalyst. As the first quarter of 2011 is quickly coming to an end, the expectation is for strong corporate profits once again and that’s what institutional investors care about. This is what’s keeping investor sentiment in stocks generally positive.

I want to repeat a sentiment I’ve been writing about recently. There isn’t any rush for investors to be making any bold new bets in this market. I remain bullish on equities this year, although the action in the Dow Jones Transportation Average is still worrisome. Investing in gold has been, and continues to be, a good idea, but that commodity is also due for a major pullback. Over the very near term, global capital markets will reflect the daily events taking place in Japan. Domestic markets are now in a correction.

Everything is due for a correction now: stocks, commodities, and several currencies. The stock market isn’t overvalued; it’s just had a great run and a correction would be healthy. In addition, the majority of the world’s commodities have also been in a bull market and they too are due for a correction.

Just because one’s economic analysis suggests that a correction would be healthy for the long-run action in stocks and commodities doesn’t mean it’s going to happen. If the S&P 500 Index pulled back 15% from its current level, I’d be a new buyer. If the price of gold retreated to $1,200 an ounce, I’d be a new buyer of gold stocks—a lot of them. From my perspective, the price trend is still up for both stocks and commodities. I’d like to see a correction in a number of markets, because I don’t like seeing securities go up in value like they’re following a straight line. I also would like a more attractive entry point for considering new positions.

If there was a pronounced correction in precious metal prices, I would seriously consider investing in gold and silver in a very meaningful way. I would take on new positions in intermediate producers as well as several juniors. I’d also own a gold fund or ETF that actually holds physical gold and silver bars in a vault. With all the risks out there (e.g. sovereign debt defaults, war, inflation, higher interest rates, housing prices, and unemployment), gold is a must-have asset. Perhaps for the rest of this decade.

Wall Street analysts and investment newsletters have been quite bullish since the beginning of fourth-quarter earnings season. Some see this as a sign that the current bear market rally is coming to an end. I don’t know what’s going to happen to stock prices, but my view is that it’s probable that the S&P 500 Index will keep ticking higher this year. My prediction is 1,500 on the index, as you know.

There’s a lot of risk out there that could sap global investor confidence and I think this is why a lot of individual investors are still sitting on the sidelines, not participating in equities in the way they were before. Individual investor confidence was decimated during the subprime financial crisis and the broader stock market still hasn’t recovered from the previous bubble in the technology sector. So, you have a situation where most of the market is being played by professional investors or speculators. This makes the price moves more pronounced and it almost removes a level of rationality from the marketplace, because all the action is with a short-term time horizon for making money.

It’s important for equity investors to keep listening to what large corporations say about their operations. It’s also very important for equity investors to follow the Dow Jones Transportation Average. This index is teetering on breaking down and it may be the best indicator yet for an upcoming stock market correction.

Oil is surging in the global markets and this has transformed into higher gasoline prices at the pump, which now average over $3.50 per gallon and may be heading higher. Gasoline prices are surging at the pumps. The jump in fuel costs will cut away at the disposable income of consumers and this would impact economic growth. The situation is made worse given that the busy summer driving season is only a few months away.

The situation in Libya continues to be a problem, as the conflict has worsened with intense fighting. There was news that Libya may enter into peace talks with the rebels and thus avert a major civil war, but this has yet to happen.

At issue is the oil in the ground that Libya is sitting above. The country has the 12th largest oil reserve in the world. Col. Qaddafi knows this and wants to keep the oil under his control. Libya has cut about one million barrels per day from its regular 1.6-million-barrel daily production. Saudi Arabia has increased its oil production to try to compensate for the loss, but oil continues to ratchet higher, with the April oil on the NYMEX trading at over $106.00 per barrel on Monday.

Basic economic analysis tells us that the surging oil prices are a real problem that could impact global economic growth. If the tensions spread through the oil-producing Middle East, oil could spike much higher and drown out the recovery.

There is news that oil-cartel Organization of Petroleum Producing Countries (OPEC) may increase its production output for the first time in two years to help offset the loss of the oil flowing from Libya. This would be positive, but again a temporary solution. The fear is that the conflict will intensify in other OPEC and non-OPEC oil producing countries in the Middle East. In this event, this would be damaging to the global economic renewal.

Technically, a look at the charts shows potentially higher prices ahead. The near-term technical picture for the April oil is bullish, with the contract holding above $105.00.

The April oil is trading above its 50-day moving average (MA) of $93.28 and well above its 200-day MA of $85.26. An upward move could target $106.95 and $108.96.

Energy mogul T. Boone Pickens, in his investment advice, suggests that oil could reach $120.00 per barrel, which is why this supporter of natural gas energy feels that the country should reduce its dependence on foreign oil. There is nothing surprising here, as a worsening of the situation in Libya and the surrounding regions could easily drive oil higher.

Jobs are picking up steam and this will help add some drive to the economic recovery. In February, the key non-farm payrolls generated 192,000 new jobs, above the consensus estimate of 185,000 and the upward revised 63,000 in January.

Better yet, the unemployment rate fell to 8.9%, below the estimate of 9.1% and 9.0% in January. I feel that the break below 9.0% is a key milestone and perhaps a turning point. The improvement was that much more important given that the unemployment rate was 9.8% in November 2010.

I have been saying how we need jobs to really add to the economic recovery and what we are seeing is a good start. And if the strong job creation continues, I sense that the economy will expand at a higher growth rate in 2011 and 2012.

In the private sector, the ADP Employment Change was better than expected, with 217,000 new private jobs in February, well above the estimate of 165,000 and the revised 189,000 in January.

And, on a weekly basis, the first-time initial claims reading for the week to February 26 was impressive at 368,000, well below the estimate of 400,000. Readings below 400,000 are positive.

Jobs will add to the economic recovery. My economic analysis is based on what is referred to as the “multiplier effect,” where a dollar spent results in more spending. For instance, you spend a dollar at the store. That dollar is used to pay workers, who in turn spend. This cycle continues and is a major driver of total spending in the economy.

For example, a worker buys a bike at the store. The salesperson makes a wage and commission and in turn buys spends money, say on a lunch at a restaurant. The salesperson tips the waitress at the restaurant, who in turn uses her tip to buy something. As you can see, the initial spending causes a domino effect in spending, which helps to drive up GDP.

Add in the new jobs and the spending will rise significantly. Factor in the multiplier effect and the new jobs generate additional growth. This can only be positive and this is what the government wants to see. Plus, more jobs mean less spending on unemployment benefits and, more importantly, increased taxes from workers returning to the workforce. This will help with the mounting deficit and debt.

We just need to see jobs continue to rise each month. The problem is that there are presently about 15.1 million Americans unemployed and looking for jobs while struggling to make ends meet. There are only about 2.9 million available jobs. Do the math. That is five unemployed workers competing for one job.

It will not be easy, but I’m encouraged by the jobs report. Let’s hope the good news continues.

The stock market is definitely in need of a correction/consolidation and the catalyst could be a combination of events: conflict in North Africa; the end of 2010 fourth-quarter earnings season; a generally tired market; and higher oil prices. Even though the stock market has gone up tremendously, investment risk is the same now as it was six months ago—high to very high.

We’ve got geopolitical events to deal with, already high commodity prices, low housing prices, high unemployment, and the sovereign debt issue, which is a simmering risk that could wreak havoc in currency markets. It’s a wonder that stock prices have gone up at all.

Still, business conditions for corporations remain positive and that’s the single most important piece of economic analysis that investors should be focused on. While events around the world do matter, Wall Street has always followed its own ethos, and it’s different from Main Street. That’s why you often see a rising stock market when economic news is weak.

Readers know that I’m long the stock market, although I view the current state of things as a bear market rally. Just owning the S&P 500 is good enough in this regard. If you want to be speculating for capital gains, the single best area for stock pickers remains precious metal stocks. Investing in gold has been and will continue to be a good idea for equity investors and I feel so strongly about this that I’d be a buyer right now, even though many of the best stocks in the sector have already appreciated substantially. I always prefer the buy-low-and-sell-high investment strategy, but as an investor with money to make bets, you have to roll with what the market offers. The best time to have made new gold stock picks was quite a few years ago, obviously.

I’m not worried about higher oil prices affecting domestic economic activity. It would take quite a while for high oil prices to kill this recovering economy and they would have to be well over $100.00 a barrel (WTI) for this to happen. What I am worried about are inflation and interest rates. This story is happening abroad, but not yet at home to the degree that economic activity would suffer. But the probability for a change in the interest rate cycle is increasing and this is what Wall Street is worried about. As long as the Fed says everything is fine (which doesn’t mean it’s right) and there’s no need to make any policy changes, the outlook for stocks is positive. Once the tone from the central bank changes, my view will be shifting significantly.

Way back in 1938, Congress established Fannie Mae with the big idea of helping homebuyers get mortgages. The government followed up the act with the establishment of Freddie Mac in 1970.

The idea behind Fannie Mae and Freddie Mac was simple: increase the amount of money available for mortgages by packaging home loans into bonds and then selling those bonds to investors. Fannie and Freddie basically insured the buyers of the bonds against losses.

With very little government oversight, as time went buy, Fannie and Freddie increased the size of the loans they could guarantee on a single property to $729,750. In time, these two government-sponsored companies came to own or guarantee more than half of all the residential mortgage debt in the U.S.

The government unwittingly brought interest rates to record lows in the summer of 2004, when a real estate bubble the size of which America had never seen was created. When it burst in 2006 and 2007, Fannie Mae and Freddie Mac fell to their knees. In fact, the government took both into what is called “conservatorship” in 2008.

Today, we have different parts of the government giving us different estimates on how much Fannie Mae and Freddie Mac have cost taxpayers since the credit crisis began. The U.S. Treasury says $169 billion. The Federal Housing Finance Agency says that the number will be between $142 billion and $259 billion. All I know, from what I see from their most recent financial reports, is that Fannie and Freddie continue to bleed red ink.

So, as a taxpayer, the taxes I pay the government from my hard-earned money could theoretically go to pay the mortgage on my neighbor’s house, because he defaulted on his mortgage and it was a Fannie-Mae-insured mortgage. You see, somewhere along the line, the Constitution was changed so that I have no right to say what our politicians can or cannot do with the taxes I pay.

Hence, how can I not be a cynic? How can I not help but be a contrarian in the stock market? Most importantly, how can I not be a gold bug?

Michael’s Personal Notes:

I have a problem with idea of the New York Stock Exchange (NYSE) falling into foreign hands. The NYSE is an American institution that has for years been the marketplace where stocks of the world’s biggest companies could be bought and sold. To me, the NYSE is the epitome of entrepreneurialism in America.

While I doubt it will be opposed, I hope either the U.S. Justice Department or the SEC, which needs to give its blessing for the deal, say no to the takeover of the NYSE by Deutsche Boerse AG. Foreigners own about 50% of all our debt securities. The Chinese have been increasingly heavy investors in American corporations, most recently moving into our banking system.

Now we will have a German-based company taking control of the NYSE. Little by little, America is being eaten away at by foreigners and we are just letting them get away with it. At the rate of foreign acquisitions in this country, as China becomes more powerful as the years pass, our most important assets will be owned by foreign interests…and our politicians just sit by and let it happen.

In Canada, the government has opposed many proposed foreign acquisitions of assets, because they are not in the best interest of the country. Foreign acquisitions of companies engaged in industries ranging from telecommunications to natural resources have been vetoed by the Canadian federal government…and the country is no worse for wear because of it. In fact, it is one of the strongest economies of the G7.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this morning up 6.1% for 2011. The bear market rally that started in March of 2009 continues riding the wall of worry higher. I still expect stock prices to rise in the immediate term, but remain very concerned about the short- to longer-term outlook for stocks, with long-term interest rising and investor optimism returning.

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.

I know it is borrowing stuff…government statistics and projections. But it’s important for my readers to see how out-of-control the debt crisis in America is. Eventually, the day of reckoning will come when the homemade debt crisis will affect the stock market, the economy and, of course, our investments and businesses.

Most forecasts now have the U.S. government deficit for the current fiscal year pegged at $1.6 trillion, about $200 billion more than the Obama Administration has previously forecast.

Please follow me on this:

The White House expects the annual deficit to fall to $1.1 trillion next year and $607 billion by 2015.

Last year, the interest on the national debt came in at about $200 billion amid interest rates that were record-low. But rates are rising and they are rising fast. I’m expecting the yield on the bellwether U.S. 10-year Treasury to smash past four percent soon. That means the interest the government expends on its debt could jump to more than $500 billion annually in the next few years as interest rates rise.

By mid-decade, we will be spending almost $1.5 billion a day on interest expenses related to the national debt. That’s if all goes well. It’s not taking into account runaway inflation; it’s not taking into account interest rates rising sharply to support the ailing greenback.

The amount of our public debt held by foreigners has declined approximately 10% over the past two years. Either we need to get more domestic investors to buy government debt or we have to lure the foreigners back as buyers of our debt. Either way, the only way to do it is that interest rates must rise, the national debt must rise. It’s a national debt crisis that gets far too little coverage from the media and the public.

Interest rate cycles are very long-term in nature, usually 25 to 30 years in length. The yield on the U.S. 10-Year Treasury rose from about 2.5% in the early 1950s to about 15% in the early 1980s—a 30-year trend of rising interest rates. From the early 1980s to last year, the yield on the 10-Year Treasury fell from 15% to 2.4%—a 30-year trend of interest rates falling.

I believe that we are on the cusp of a new long-term trend of rising interest rates. No one in the 1950s, 1960s or 1970s would have ever believed that interest rates would go to 15%…and they did. Ask around today. If you tell the average investor that interest rates are headed to 10% within 10 years, they will laugh and say, “Can’t be possible.” And that’s why it’s going to happen.

The worst of the debt crisis is yet to come. Investors should be reviewing their portfolios, their investments, to prepare for the effects of sharply higher interest rates.

Michael’s Personal Notes:

Something historic happened this morning…

Japan confirmed that China had surpassed it as the world’s second largest economy in 2010.

The growth is staggering. In the year 2000, the total GDP of China was a paltry $1.2 trillion, about 12% of U.S. GDP that year. Fast-forward to 2010 and China’s GDP was $5.88 trillion last year, about 40% of U.S. GDP.

Will China be able to keep up this unprecedented annual growth without some form of social upheaval? Can growth be that organized? I have my doubts. But we can’t argue with the facts.

If China keeps growing the next 10 years like it has the last 10 years, by the end of this decade, China’s economy will be equal to about 70% of the U.S. economy. The writing is on the wall. The balance of economic power is slated to shift from the West to Asia over the next 10 to 15 years.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average starts this week up an even six percent for 2011.

I believe that the bear market rally in stocks has more immediate-term gain left on the upside. Shorter-term, over the next two to four months, I see trouble for the stock market, as interest rates rise in an environment of ever increasing bullishness. Hence, why I’ve been turning bearish for the remainder of 2011.

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 of 2007. The index fell to 6,440 by March 2009.

Stocks continue to edge higher following the recent breakouts by the DOW and S&P 500, which are at their highest levels since June 2008. The bias continues to be bullish. There is some hesitancy on the charts, but stocks are powering higher. The DOW, NASDAQ, and S&P 500 are all up over five percent this year, with blue-chip stocks leading the pack.

It’s clear that the bias is bullish, but be careful. The light trading volume during this recent rally is a concern and points to a minor divergence between price and volume. During a rising market, you want to see higher trading volume in order to confirm the rally.

Technically, the stock charts continue to point to potentially more gains.

Investor sentiment has been extremely bullish.

Take a look at the new-high/new-low ratio (NHNL). The trend of the New York Stock Exchange NHNL had been edging higher, with 143 of the last 149 sessions to February 9 showing a bullish bias. The near-term trend is positive.

In the technology area, 102 of the last 107 sessions have been bullish.

As long as the investor sentiment continues to be bullish, I expect stocks will attract buying support.

I have presented my near-term technical views below.

NASDAQ

The near-term technical picture is bullish on strengthening Relative Strength (RS), so there could be more upside gains in the near term.

The index is above 2,700 and holding well above its chart top of 2,320.

The NASDAQ is holding above its 50-day moving average (MA) of 2,672 and 200-day MA of 2,408. The 50-day MA is above the 200-day MA and showing a bullish golden cross.

Watch out, as the index is overbought and we could see some hesitation on upward moves.

DOW

The near-term technical picture for the DOW is bullish on strengthening RS, so there could be additional gains in the near term. The DOW was on a nice eight-day winning streak before a small decline last Thursday halted the streak.

We feel that 12,000 could prove to be a battleground.

The index is above its 50-day MA of 11,578. The 50-day MA is holding above its 200-day MA of 10,833.

Watch, as the index is overbought.

S&P 500

In the broader market, the near-term technical signals for the S&P 500 are bullish on strengthening RS, so there could be more gains.

The month of February has not been kind to the S&P 500 in the majority of the past 12 years when the index fell in February on eight occasions.

So far it looks like February may be an up month.

The index is above its 50-day MA of 1,254 and 200-day MA of 1,157. The 50-day MA is above its 200-day MA.

Watch the index, as it is overbought.

RUSSELL 2000

The near-term picture for the Russell 2000 is bullish on strengthening RS, so watch for some more gains. The 800-point level is proving to be a key point.

The index is above its 50-day MA of 776 and the 200-day MA of 692.

SCI

Meanwhile, overseas in China, the Shanghai Composite Index (SCI) has edged higher following the one-week Lunar New Year break. The index is holding above 2,800 and is up 0.68% this year, which is subpar versus U.S. indices, but encouraging given the weak performance in 2010. We suspect traders are happy with the government’s efforts to battle inflation in spite of higher interest rates.

In all, you should ride the gains, but also make sure you have some risk-management tools in place, such as stop-losses or Put options.

As was widely expected, China’s central bank raised interest rates for the second time in a month and the third time since October in an effort to fight surging inflation and speculative real estate buying. The speculation is that the central bank will increase interest rates two additional times by the mid-year. While it may not be what you want to hear due to its potential impact on Chinese growth, the higher rates are necessary and make sense.

The reality is that China continues to report impressive GDP growth and, yes, higher rates could slice off some of the growth, but longer-term it will only help create stability and growth.

The Organization for Economic Cooperation and Development (OECD) predicts that China will grow its economy by 9.7% in 2011 and 2012. While lower than the previous rates, this is still well above the global averages of 4.2% and 4.6% in 2011 and 2012, respectively.

I view the growth of China over the past decade as akin to the Industrial Revolution that started in the United Kingdom in the 18th century and spread across Europe, to the U.S., and around the world.

But, with all the growth come rising prices, or inflation. Inflation is estimated by economists to rise to an annualized 5.3% in January. China has not seen inflation at these levels in over 25 years. The target inflation rate was raised to four percent from the previous three percent.

Prices across the board have been rising in the country. Food prices are surging across the country due to the higher commodity prices. The government has come in to help subsidize the rapidly rising prices, but this is only a temporary measure for a deeper problem.

When a country is growing at the rate China has been, it is not unreasonable to see inflation. The country is placing a cap on essential foods such as cooking oils to try to help the many poor people.

Real estate values, while rising at a lower rate, continue to move higher despite the government’s efforts to tighten the flow of money via higher bank reserve ratios. China increased the bank’s reserve ratio to 18.5%, representing the fifth increase in 2010 and the third in over a month. The reality is that this does not appear to be working and the government may need to further increase interest rates to dampen the lending demand.

China estimates that it has targeted about US$1.05 trillion in bank lending in 2011, which still appears to be relatively high, but lower than the expected $1.35 trillion in 2010. Some economists feel that the lending should be US$975 billion to US$1.0 trillion for 2011.

In my view, China’s central bank finally appears serious about tackling the inflation by increasing interest rates. And my gut feeling is that higher interest rates are around the corner in China.

Okay, I’ve been saying it since the summer. I’ve been writing about it almost weekly. And now I want you to see it.

Below is the price chart of the 10-Year U.S. Treasury Note.

Chart courtesy of StockCharts.com

From this price chart, you can see that the yield on the bellwether 10-year Treasury has risen from 2.4% in October of 2010 to 3.7% yesterday, an astounding 54% increase in long-term interest rates in only four months!

The Federal Reserve can manipulate short-term rates, as it sets the Federal Fund Rate, but the Fed cannot manipulate the direction of long-term interest rates. The current $600-billion QEII the Fed is implementing is case in point of failure to change the direction of long-term interest rates.

Why is this the most important chart of the year?

The chart of the 10-year U.S. Treasury is so important, because it shows that long-term interest rates are rising sharply. Obviously, this will eventually have a negative impact on the stock market and the economy.

Three events (or a combination of them) could be causing long-term interest rates to rise so sharply:

The bond market could see U.S. economic growth better than expected over the long term. The bond market could be predicting higher inflation ahead. The bond market could be pricing in higher rates on U.S. Treasuries (government debt), as foreigners demand greater return on their funds, as the greenback devalues in light of growing national debt.

Short- to long-term, a stock market does not rise when long-term interest rates are rising so quickly. Nor does an economy grow in the wake of sharply higher long-term interest rates. Think the housing market. How can it ever recover if rates for mortgages keep rising? Long-term, this chart tells me there is trouble ahead.

Michael’s Personal Notes:

I’m sad to say it, but it’s true. After being married for 20 years, I’ve run out of ideas on what to do for my wife for Valentine’s Day this year. Here’s the problem. My wife does not like gifts. She prefers any gifts to her (from me or the kids) to be in the form of a donation to a worthy cause, even if it’s $100. She’s at the point in her life where she only buys what she needs and that’s it. Chocolates and flowers? After 20 years, too boring for me to even consider.

To compound things, if there are two days of the year I hate going to restaurants it’s Valentine’s Day and Mother’s Day. There are 363 other days of the year we can go out where service will not be poor, it won’t take three hours to eat a meal, and the restaurants won’t be so full that you need to become best friends with the table next to you.

This morning I thought, hey, I have a couple of hundred thousand friends; why not ask them for some ideas on how I can make this Valentine’s Day memorable? I’m serious. If you can send your comments and ideas, I would really appreciate it. In fact, I promise to read every one.

The trials and tribulations of Valentine’s Day!

Where the Market Stands; Where it’s Headed:

Up, up and away, that’s where the market is headed. Day after day, stocks are rallying and the naysayers can’t believe it. Hmm. Who has been saying four times a week, since December, that stocks would rally in the immediate term? Oh, that’s me! (Forgive me, dear reader, in this business, where the market’s job is to trick analysts like me at every step of the way, you need to grab that limelight when you can.)

The Dow Jones Industrial Average opens this morning up 5.7% for 2011…a great start to the year. But short- to long-term, I’m still turning bearish. The pressure on long-term interest rates to rise is boiling (see lead article today) and there’s too much bullishness out there. Enjoy the rise in stock prices while it lasts.

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 that 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.”

There are presently about 15.1 million Americans unemployed and looking for jobs while struggling to make ends meet. The problem is that there are only about 2.9 million available jobs. Do the math. That is five unemployed workers competing for one job. You don’t have to be a mathematician to figure out there is something wrong with this equation.

The ADP Employment Change for January saw the creation of 187,000 jobs, above the consensus estimate of 145,000, but well below the revised 247,000 in December. The shortfall was blamed on the snowstorms impacting about 70% of the country.

The initial claims for the week to January 29 saw a decline of 29,000 claims to a seasonally adjusted 415,000, better than the estimate of 425,000. The problem is that economists believe the weekly claims would need to fall below 375,000 to drive down the unemployment rate. At the current level, there is only modest job growth, and this was made evident last week.

There were high hopes for a strong non-farm payrolls reading. Sorry to disappoint.

The country added a disappointing 36,000 jobs in January, well below the estimate of 148,000 and the revised 121,000 in December. The only positive was a major decline in the unemployment rate to 9.0% from 9.4%, well below the 9.5% estimate. The decline may be due to workers leaving the workforce and not looking for work. The bottom line is that the dismal lack of job creation continues to point to a problematic jobs market.

So, what happened?

Quite simply jobs are not being created as fast as the government had hoped, despite it spending hundreds of billions on infrastructure and incentives and, in the process, building a massive deficit and adding to the over $14.0 trillion in national debt.

You’ve got to worry about this.

The problem is that jobs drive confidence and this gives consumers a reason to spend, especially on non-essential goods and services. The Durable Goods Orders for January fell a disappointing 2.5%, short of the 1.5% growth expected. Excluding transportation, the reading increased 0.5%, but it was below the 0.6% estimate and the 4.5% reading in December. The readings suggest that consumers are not yet comfortable spending on non-essential goods and services.

And when consumers do not spend, there is a domino effect down the line. In economics, this is known as the “multiplier effect,” where a dollar spent results in more spending. For instance, you spend a dollar at the store. That dollar is used to pay workers who in turn spend. This cycle continues and is a major driver of total spending in the economy.

This is why jobs are so important for increasing consumer spending and driving the economy. And this is why the jobs report was a major disappointment.

I look at the U.S. job report numbers released by the Labor Department on Friday, and I just need to laugh inside. It was a terrible report. But the news media didn’t see it that way. Most news sources said that the stock market was rallying on Friday due to the strength of the job report numbers. Rubbish.

Here is the real story behind the job numbers:

The official unemployment rate in the U.S. fell from 9.4% in December to 9.0% in January. This is the figure that got the media all excited.

But the reality is that the unemployment rate didn’t go down because more jobs were created; it went down because people stopped looking for work. People discouraged from finding employment and not actively seeking work are not counted as unemployed in the official calculation.

Only 36,000 new jobs were created in January, the smallest gain in four months. Employment analysts were predicting well over 100,000 new jobs for January, a far cry from what was actually reported.

During the recession, the U.S. lost about nine million jobs. A devastating number no matter how you slice it. We are far from recovering that tragic loss of jobs, and I’m simply in the camp that believes we will never fully recover from those job losses.

After years of following how the Federal Reserve sets interest rates policies, I doubt that the Fed will want to raise short-term interest rates until it sees consecutive months where jobs created are equal to 150,000 or more. Hence, the Federal Funds rate may stay unchanged (near zero) all year long, which will conflict with rising long-term interest rates (see “Michael’s Personal Notes” below).

In my humble opinion, January’s job report number is just more evidence that we are far from “out of the woods” with this economy…that maybe the stock market is getting a little ahead of itself…that cuts in government spending could be more a fantasy than reality… that in our desperate effort to create jobs will come the broad-based damage of higher inflation and higher interest rates.

Michael’s Personal Notes:

Finally, a news source has picked up the surge in long-term interest rates. From Bloomberg on Saturday: “Treasury 10-Year Yield Reaches a Nine-Month High as Recovery Builds Steam.”

Since November, I’ve been writing extensively about the rise in long-term interest rates, as few events can impact the stock market or economy to such a degree as higher interest rates can. While the Federal Reserve has kept the benchmark Federal Funds rate near zero since December of 2008 (what I would call a desperate Great Depression type of tactic), long-term interest rates have been moving sharply higher.

The 10-Year U.S. Treasury opens this morning at 3.65%, the highest level since May of 2010. My prediction is that we will soon see the 10-Year Treasury at four percent, bringing it to a new post-recession high. Obviously, as interest rates rise, the price of bonds comes down. I’ve been begging my readers to get out of bonds since the summer of 2010—hopefully most heeded my suggestion.

What do rising long-term bond yields mean?

They can mean three things (or a combination of the three). Firstly, the bond market could see U.S. economic growth get better over the long term. Secondly, the bond market could be predicting higher inflation ahead. Or thirdly, the bond market could be pricing in higher rates on U.S. Treasuries (basically government debt), as foreigners demand greater return on their funds, as they see the greenback going down or U.S. national debt becoming a problem in the months and years ahead.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this morning up 4.5% for 2011. I’ve been quite steadfast that, in the immediate term, stocks will continue to rise, while, for the short to long term, I’m turning bearish on stocks. I have no reason to change that opinion at this time.

Unless I see the Dow Jones Industrials breakthrough the 14,164 level, I continue with my opinion that the stock market rally that started in March of 2009 is in the confines of a bear market. Enjoy the stock market profits while they last!

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.

Long-time subscribers know my fondness for stock price charts in determining future trends. I believe, most of the time, that the price of stocks are a leading indicator of what lies ahead, especially for individual stock sectors.

Months before the turmoil in Egypt erupted, the price of oil started to rise. After crashing to a low of about $30.00 a barrel in the depth of the 2008 financial crisis, oil came running back to $91.00 a barrel. (While the Dow Jones Industrial Average is up 87% from its 2008 low, the price of oil has risen 200% since its 2008 low.)

Looking at the charts right now, the Dow Jones U.S. & Gas Index literally shows a straight line upward from September 2010, when the index traded at 440, to 635 today—a gain of 44% in five months. The chart screams of higher stock prices ahead for the oil companies—which the market obviously relates to higher crude oil prices.

Blame the exploding economies of China and India, a colder-than-expected 2010/2011 winter in the northeast U.S., an improving North American economy, tensions over the Suez Canal, and recovering car sales worldwide, but the stock price charts indicate that oil prices will continue to rise.

Now my two contrarian spins on rising oil prices:

Firstly, rising oil prices are inflationary. With inflation come rising interest rates. Secondly, crude oil is priced throughout the world predominately in U.S. dollars. As the U.S. dollar continues its long-term devaluation against other world currencies, the price of oil rises, because it takes more real U.S. dollars to purchase crude.

I’ve often looked at crude as a “put” against the declining value of the U.S. dollar. The more the greenback falls in value against other world currencies, the higher oil prices move. Who knows; maybe one day world oil producers will demand payment for their crude in non-U.S. dollars. Anyone say “gold?”

Michael’s Personal Notes:

While I was driving downtown late yesterday afternoon, I was listening to the radio. Three CNBC journalists were interviewing the president of Newmont Mining Corporation (NYSE/NEM).

The first asked about what happens when gold prices run up to $1,500 an ounce and come running back down. Another asked why Newmont doesn’t hedge its bets, with the price of gold so high right now. A layperson listener like me couldn’t help but notice that all three of the CNBC interviewers were negative or bearish on gold.

When the president of Newmont got off the phone, one interviewer basically said to another interviewer, “What happens when the price of gold bullion comes crashing below $1,000 per ounce; how hard will Newmont stock get hit?”

My two points on this: the majority of investors do not believe that the price of gold will continue to rise. Wednesday, I quoted a recent Bloomberg poll that said more than half of 1,000 investors polled thought the gold market was in a bubble. As long as this negativity towards gold bullion exists, the price of gold will continue to rise.

Secondly, there was no mention during the CNCB Newmont interview of the effects of the price of gold, because the U.S. greenback is devalued against other major world currencies. This is key; the purchasing power of the U.S. dollar is a major factor in the pricing of gold bullion.

After Barrick Gold Corporation (NYSE/ABX), Newmont is the second-largest producer of gold in the world. The amount of $10,000 invested in Newmont stock in 2001 would be worth $38,220 today, even after the recent correction in the gold prices. Newmont has been an excellent way to play the run-up in gold prices.

Where the Market Stands; Where it’s Headed:

More of the same…with all the liquidity in the financial system, with investors wary of putting their money in bonds as interest rates rise (bonds fall in value when interest rates rise), with the economy looking like it is getting healthier every passing day, and with corporate earnings rising, why won’t investors put money in stocks?

In the immediate term, I expect stocks to continue rising. Short- to long-term, it is a different story. Yesterday, the 10-year U.S. Treasury hit a high not seen since May of 2010. Interest rates are going up globally.

The Dow Jones Industrial Average opens this last trading day of the week up 4.2% for 2011.

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 $690.0-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 under $300.00 an ounce when Michael first started recommending gold-related investments. Many gold stocks recommended in Michael’s advisories gained well in excess of 100%.

What a difference six months makes. Last summer, investor sentiment was so bad that stocks were selling off on good corporate news. Now everything seems rosy again. The stock market is going up, commodity prices are strong. All an investor has had to do over the last six months is just own the market. So why are things rosy on Wall Street and only mediocre on Main Street?

The answer lies with the Federal Reserve and the central bank’s policy to keep the world awash in cash and interest rates artificially low. This helps Wall Street much more quickly than it does Main Street. Traders and investors would rather place their bets on stocks over real estate. It’s all about liquidity and the ability of investors to trade within it.

Eventually, though, the central bank is going to have to reverse course. It can’t keep pumping up the system forever. The hope among monetary policy makers is that the economy will be strong enough to grow on its own and then the Fed can withdraw some stimulus without negatively impacting the economy. What’s holding the central bank back from raising interest rates right now is mostly the employment situation. The job market isn’t healthy enough yet for changes to the monetary policy, but the stimulus is creating price inflation on Wall Street (stocks and commodities). It’s not yet happening on Main Street (jobs and income).

So, we have a situation where the stock market keeps ticking higher, even in the face of major uncertainty in the Middle East. Institutional investors are happy to buy stocks, because corporate earnings are growing and interest rates are so low. It’s a perfect world for Wall Street and there is a lot of hope out there. Investors are buying stocks based on those hopes and it’s the typical move: buy on anticipation, sell on the reality. The reality, however, has yet to reveal itself.

The stock market is due for a major correction, but it needs a catalyst. So far, geopolitical uncertainty has proven to barely affect sentiment. Even lackluster employment numbers and flat housing prices can’t dent investor enthusiasm at this time. We have a bull market in an overall bear market, and it’s all because of the Fed.

Large-cap indices should continue to do well over the near term, because so many of these businesses are well diversified internationally. Asian operations are providing the growth, while European and American operations are slowly improving.

The right shoulder on the S&P 500 Index continues to form and it’s eerily similar to the left shoulder. Pull up a long-term chart on the index and you’ll see an amazing pattern that’s very symmetrical. It certainly leaves you wondering what the next major price trend will be. Whatever it is, it will be due to inflation.

Recent developments are placing tremendous pressure on European countries to raise interest rates. The spillover will result in higher rates here. Here’s what my readers should know:

Unemployment in Germany fell to an 18-year low in January, as boom times are back at the world’s second largest exporting country. This smells of rising interest rates.

Inflation in the 17 countries that use the euro (known as the Euro Zone countries) rose at an annual rate of 2.4% in January. European Central Bank (ECB) president Jean-Claude Trichet has publicly stated that inflation must be kept in check in Europe (ECB’s target inflation rate is two percent). Higher interest rates in the air here, too.

London-based National Institute of Economic and Social Research said on Tuesday that the Bank of England will likely raise interest rates three times in 2011 to fight inflation.

Sure, there are those who say that European countries need to raise interest rates to support the fragile euro, but I don’t see this as a conspiracy to support the euro. The United Kingdom never adopted the euro, interest rates pressures are also mounting in China and Japan, and world food prices are rising rapidly (with sugar prices at a new 30-year high this morning).

While it may be in the best interest of the United States to keep interest rates low compared to the rest of the world in an “off the books” greenback devaluation play, my readers need to keep know about these two important facts:

In a letter to the Financial Crisis Inquiry Commission from Fed Chairman Ben Bernanke dated December 21, 2010, Bernanke says that the Fed failed in 2005 to see the risks in the housing market. Do you think the Fed will hesitate to raise interest rates if the Dow Jones Industrials hit 13,000 or 14,000 in an effort to fend off another stock market bubble? I think it will.

Finally, the chart of the bellwether 10-year U.S. Treasury shows that a base has been forming at the 3.4% level since mid-December to today. I believe that base will act as the foundation for a move by the 10-year Treasury to its next stop of four percent. The yield of the 10-year Treasury is up 41% since October 2010 and keeps pushing higher.

Welcome to America’s latest imports, inflation and higher interest rates.

Michael’s Personal Notes:

Optimism on the U.S. economy is getting a little ahead of itself and this is reason for concern for me.

According to the National Association for Business Economics in Washington, U.S. companies’ employment outlook is at a new 12-year high. American businesses are planning to aggressively increase their payrolls over the next six months.

In a poll of 1,000 qualified investors conducted by Bloomberg over January 20 to 24 of this year, it was found that global investors are targeting the U.S. as “one of the best places to put their funds as they grow increasingly confident in the economic outlook.”

I’m a contrarian at heart. I like to buy stocks when everyone is worried about the economy and selling stocks (2008, 2009). Once I see investors and analysts starting to turn so bullish, I start to get worried and actually start to think in the opposite direction—things are not as rosy as they seem.

(The same Bloomberg poll noted above also asked investors about gold. More than half asked said that the gold market is in a bubble. This is music to the ears of a gold bug like me.)

Where the Market Stands; Where it’s Headed:

On this site on January 28, 2011, I wrote, “When will we get that (Dow Jones Industrial Average) close around 12,000? Soon, dear reader, soon.” That “soon” happened yesterday, with Dow Jones Industrials plowing through to 12,040. The world’s most followed stock market index opens this morning up 3.9% for 2011.

Since December, I have said that, in the immediate term, stocks would move higher. I have no reason to change that opinion. There is tremendous pressure on stocks to rise: Corporate earnings are strong, there is a lot of money on the sidelines to enter the market and move it higher, and now the stock market is being viewed as a safe haven against the U.S. dollar (how quickly we forget 2008).

But all good things come to an end. The short- and long-term outlooks are exactly the opposite of the immediate term: Too many bullish investors, rising inflation, rising national debt, a devaluation of the greenback and rising interest rates—a lethal combination for the market. Enjoy the rally while it lasts!

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 waits…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 began experiencing in 2008 long before anyone else.