These two benchmark companies offer the first glimpse of business conditions for multinational corporations. What they report is material.

Last quarter, NIKE surprised Wall Street with excellent relative growth in revenues and earnings, particularly in the North American market. Oracle came in just under consensus. The stock’s been treading water for the last several months.

Corporations have been coy with their earnings guidance, both out of the collective uncertainty regarding the economy and to make it easier to beat the Street. It’s always a delicate dance that corporations play with investors. Earnings are definitely managed, which is why it’s important to look at cash flow and other financial metrics to get a better understanding of a company’s performance.

If there’s one trend apparent in the financial results of large corporations, it’s that balance sheets have been getting stronger. And this bodes extremely well for dividend-seeking investors. I have a strong inclination this earnings season that we’re going to see continued increases in dividends and expanded share buyback programs to pay for them.

Generally speaking, I wouldn’t be buying this market, but I wouldn’t sell blue chip positions either. Market timing is always extremely difficult, but it’s pretty tough to make the case that stocks aren’t due for a break.

While there’s been some peculiar trading action over the last week in global capital markets, there is still an appetite on the part of big investors to buy stocks if earnings meet or beat consensus.

First-quarter earnings season saw corporations report revenues that were mostly underwhelming. Some of the best blue chips like Johnson & Johnson (JNJ) and PepsiCo, Inc. (PEP) really hit the mark with their earnings, and they did produce genuine sales growth that the stock market rewarded.

All the market wants to see is continued stability in earnings, along with genuine constant currency growth in revenues. It doesn’t have to be double-digits, but it does have to be real.

We have seen some good numbers from select corporations like Cabela’s Incorporated (CAB) and Costco Wholesale Corporation (COST), which are representative of improved consumer confidence. For a number of quarters now, corporations reported that price increases were not materially affecting demand. (See “Big Investors Still Buying Big-Caps; Will They Be Right?”)

One thing I’m not loosing sight of is the fact that this market has been due for a meaningful pullback for a number of months. A stock market correction is overdue and would be a very natural development after such strong capital appreciation.

This market won’t fight monetary policy, but I think it is looking for a catalyst to sell.

This week, it’s time for two corporations to produce: FedEx Corporation (FDX) and Oracle.

Yet the super-rich may surprise you. Out of the approximately 200 billionaires in China, about 83 are politicians, so you know who really runs the country and is getting rich. (Source: Anderlini, J., “Chinese parliament holds 83 billionaires,” Financial Times, March 7, 2013, last accessed June 17, 2013.) That’s unbelievable, and you know that these wealthy politicians probably can do whatever they desire, worrying very little about any conflict of interest.

China also has about 1.3 million millionaires—which trails the United States at 5.9 million and Japan at 1.5 million, according to the Boston Consulting Group. (Source: Barris, M. and Jing, S., “China to Top Japan in millionaire stakes,” China Daily, June 1, 2013.)

For Father’s Day, you can satisfy your appetite with a three-course dinner at Morton’s at The Regent Hotel in Beijing for US$135.00, or how about champagne, wine, and beer for $80.00 each at the Senses Signature restaurant at The Westin Beijing.

But while the country is seeing a renaissance in wealth creation at a pace never seen in the history of the world, the fact is that 70% of the country can still only dream of a dinner at Morton’s. It would take months for the worker in the fields to earn enough for a meal at Morton’s.

Make no mistake about it; the wealth creation out of China is unbelievable. And trust me: it’s going to continue to grow as the gap between the rich and poor broadens further.

So while the country is seeing some stalling in its gross domestic product (GDP) growth, the rich will continue to have money to spend and spoil themselves with, buying lavish goods and services, including jet-setting to Paris and Italy to buy high-end goods on weekend trips.

What this means is that there is a vast opportunity for those companies dealing in the high-end goods and services, whether they are fashion, automobile, watches, or travel companies.

The country has become a target for companies looking for big spenders who are willing to plunk down big dollars for goods, which is why we are seeing a major push of luxury goods providers into China, including Tiffany & Co. (NYSE/TIF), Coach, Inc. (NYSE/COH), Michael Kors Holdings Limited (NYSE/KORS), BMW, Rolls-Royce Holdings plc, and Rolex, to name just a few. (Read “It’s Good Times for the Rich: Luxury Spending Surging Worldwide.”)

And in China, the money does grow on trees; it’s just a matter of owning the tree.

As the volatility continues in gold bullion prices, the fundamentals remain strong. Actually, demand for gold coins is unprecedented right now.

Aside from individual investors buying gold bullion, central banks continue to diversify their reserves into gold bullion as fiat currencies fail to protect their wealth. In spite of the decline in gold bullion prices, as has been well documented in these pages, central banks form Russia, Turkey, and Kazakhstan continue to add precious metals to their reserves.

Bullish stock advisors are forgetting that we are standing on the cusp of a global economic slowdown—an event that bodes well for gold bullion. It may be difficult for my readers to envision right now, but with the recent exodus by investors out of U.S. bonds, once the stock market starts declining, there will be few other “stores of wealth” for investors to seek aside from gold.

Major economic hubs have been slowing down for some time and now, they are taking with them smaller nations that rely on their demand. China, Japan, India, Australia, Germany, and France—they are all begging for economic growth.

But instead of getting growth, world economies are slowing. The World Bank lowered its forecast for global growth last week. It now expects the global economy to grow by only 2.2% in 2013, down from its previous estimate of 2.4%—and by the end of this year, I wouldn’t be surprised to see that forecast fall again

Meanwhile, while the politicians say there is no inflation, even the government’s own out-of-whack official figures show inflation is a problem.

The Producer Price Index (PPI), an early indicator of inflation, increased 0.5% last month (source: Bureau of Labor Statics, June 14, 2013)—annualized, that’s six percent a year in wholesale inflation that will eventually make its way to consumers!

The Federal Reserve continues to print $85.0 billion a month to purchase government bonds and mortgage-backed securities, even after seeing that aggressive money printing did not work for the Japanese economy.

Dear reader, the historical fundamental reasons that drive gold prices are still present. Gold bullion prices have come under pressure, because there’s a notion that the U.S. economy is improving and conditions are getting better. Imagine that: the U.S. economy has turned the corner because the Federal Reserve has printed trillions of dollars in new money! That doesn’t sound right to me; it actually sounds artificial.

Gold bullion prices still have a bright future. And I don’t expect the scrutiny in the precious metal to last much longer. When all the pieces of the puzzle come together, the gold bears will realize they were wrong.

What He Said:

“We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in Profit Confidential, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low interest rate policy when the Fed first dropped interest rates to one percent in 2004.

According to an analysis done last week by the Wall Street Journal, in the first quarter of 2013, corporate earnings growth of companies in the key stock indices like the S&P 500 wasn’t really due to companies doing better. Rather, “research tax breaks” are what pushed 1Q13 earnings up for many S&P 500 companies. (Source: Wall Street Journal, June 14, 2013.)

Consider Intel Corporation (NASDAQ/INTC). The company spent $10.1 billion on research and development, which essentially lowered its effective tax rate from 28.2% in the first quarter of 2012 to 16.3% in the first quarter of 2013! This bolstered Intel’s corporate earnings.

Other big names in the S&P 500 like Google Inc. (NASDAQ/GOOG), Abbott Laboratories (NYSE/ABT), The Boeing Company (NYSE/BA), Yahoo! Inc. (NASDAQ/YHOO), and Xerox Corporation (NYSE/XRX) were able to use “research tax breaks” to also boost their corporate earnings.

While this technique helped companies boost 1Q13 earnings, profit expectations aren’t so rosy going forward.

Expectations for corporate earnings for the S&P 500 companies continue to drop. At the end of the first quarter (March 31), second-quarter corporate earnings were forecasted to grow at 4.5%. Now, corporate earnings growth for the second quarter is estimated to be only 1.3%. (Source: FactSet, June 7, 2013.)

Only four out of 10 industry sectors in the S&P 500 are expected to show corporate earnings growth in 2Q13. The information technology sector of the S&P 500 is expected to report a decline of 6.3% in corporate earnings this quarter and the health care sector could see its profits slide four percent!

Estimates for 2Q13 corporate earnings, in my opinion, are still too high. Underlying economic conditions haven’t improved and companies face severe revenue pressures. After all, the U.S. economy isn’t an island isolated from events in the global economy.

A significant portion of U.S.-based S&P 500 companies (about 40%) operate in regions like the eurozone and China—regions that are experiencing economic slowdowns. This means corporate earnings of companies based here at home are fragile.

Optimism surrounding rising key stock indices are not supported by corporate earnings. Investors beware!

Michael’s Personal Notes:

There has been increased volatility in gold bullion prices as investors run from precious metals. According to data compiled by Bloomberg, gold bullion’s 60-day historical volatility reached 28.9% on June 13. This was the highest level since December of 2011. Average volatility over the past five years for gold bullion prices has been around 20%. (Source: Bloomberg, June 14, 2013.)

As the volatility continues in gold bullion prices, the fundamentals remain strong. Actually, demand for gold coins is unprecedented right now.

Aside from individual investors buying gold bullion, central banks continue to diversify their reserves into gold bullion as fiat currencies fail to protect their wealth. In spite of the decline in gold bullion prices, as has been well documented in these pages, central banks form Russia, Turkey, and Kazakhstan continue to add precious metals to their reserves.

Bullish stock advisors are forgetting that we are standing on the cusp of a global economic slowdown—an event that bodes well for gold bullion. It may be difficult for my readers to envision right now, but with the recent exodus by investors out of U.S. bonds, once the stock market starts declining, there will be few other “stores of wealth” for investors to seek aside from gold.

Major economic hubs have been slowing down for some time and now, they are taking with them smaller nations that rely on their demand. China, Japan, India, Australia, Germany, and France—they are all begging for economic growth.

But instead of getting growth, world economies are slowing. The World Bank lowered its forecast for global growth last week. It now expects the global economy to grow by only 2.2% in 2013, down from its previous estimate of 2.4%—and by the end of this year, I wouldn’t be surprised to see that forecast fall again

Meanwhile, while the politicians say there is no inflation, even the government’s own out-of-whack official figures show inflation is a problem.

The Producer Price Index (PPI), an early indicator of inflation, increased 0.5% last month (source: Bureau of Labor Statics, June 14, 2013)—annualized, that’s six percent a year in wholesale inflation that will eventually make its way to consumers!

The Federal Reserve continues to print $85.0 billion a month to purchase government bonds and mortgage-backed securities, even after seeing that aggressive money printing did not work for the Japanese economy.

Dear reader, the historical fundamental reasons that drive gold prices are still present. Gold bullion prices have come under pressure, because there’s a notion that the U.S. economy is improving and conditions are getting better. Imagine that: the U.S. economy has turned the corner because the Federal Reserve has printed trillions of dollars in new money! That doesn’t sound right to me; it actually sounds artificial.

Gold bullion prices still have a bright future. And I don’t expect the scrutiny in the precious metal to last much longer. When all the pieces of the puzzle come together, the gold bears will realize they were wrong.

What He Said:

“We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in Profit Confidential, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low interest rate policy when the Fed first dropped interest rates to one percent in 2004.

The convulsions taking place in the Japanese capital markets are emblematic of the monetary exuberance that both captivates investor sentiment and distorts its reality.

It’s a trader’s paradise with such volatility, based not on Main Street fundamentals, but on the ability and willingness of policymakers to puppeteer capital markets.

While liquidity and certainty are hugely important to investor sentiment, all the financial engineering should soon produce its own blowback. Investment risk in capital markets remains high.

Investor sentiment among institutional investors in U.S. equities still has strength to carry this market higher if corporations perform.

Corporate earnings are managed, but that’s how the system works. There’s been a paring down of earnings estimates for the second quarter.

E. I. du Pont de Nemours and Company (NYSE/DD), or simply DuPont, reduced its expectations for its first half of operating profits due to the weather (the wettest spring in almost 120 years in the farmbelt states). The company said full-year earnings per share will be at the low end of its forecast, between $3.85 and $4.05. Agriculture is the company’s most important operating division. (See “Why DuPont’s Earnings Results Are So Typical for This Stock Market.”)

Capital markets, especially the equity market, are looking for catalysts. From what I read, there are still great expectations for the Japanese equity market. Unscientific investor sentiment among fund managers maintains an outlook of perpetual volatility in that market.

Getting back to the U.S. market, economic news is not robust, but there is a positive disposition to the data. Last week’s retail sales growth number was good and lower-than-expected initial claims for jobless benefits also surprised, turning investor sentiment around.

Economic data are helping investor sentiment at a time when it needs it—the lull between earnings seasons. Capital markets will still convulse in this overly monetized world, but volatility in bonds and currencies should diminish as we get into corporate earnings.

Along with many equity market participants, I have low expectations for the second quarter. I think the earnings results will mimic the economic news demonstrated throughout the quarter. There was a real mixed basket of performance with no one statistic galvanizing investor sentiment.

The great monetary experiment that’s unfolded has definitely left a profound hesitation in capital markets. While outlooks always change, there is a lack of conviction on the part of Wall Street analysts and economists as to how things are going to unfold.

Predictions about the equity market were way off. Predictions about oil prices and the U.S. dollar were off the mark, too.

The profound intervention in capital markets by central banks around the world has left a vacuum of indecisiveness and fragility. Investor sentiment has no conviction.

The only certainty is the collective bewilderment of what happens when all this monetary stimulus is withdrawn.

The Federal Reserve is going to surprise capital markets sometime soon with a reduction in quantitative easing. While I recognize what central banks have done in terms of providing liquidity and stabilizing investor sentiment since the stock market crash, it’s time to get central banks out of their turbocharged monetary easing modes.

Capital markets have been cavitating recently, butting heads against monetary forces that are clearly untenable. While it will be a rocky road (and lucrative for traders and hedge funds), it’s time to let capital markets chart their own paths.

As we move along into our discussion and dinner, I was really not surprised to hear that he was disappointed by the lack of a pullback in the stock market.

The S&P 500 was down five percent a few weeks back. At that point, I was hoping for a more sustained pullback; just like my friend, I had cash around and was ready to pounce on a buying opportunity in the stock market that subsequently really never materialized.

I could have accumulated on the five-percent adjustment, but my feeling was that there was more to come and there would be a bigger sale on Wall Street. (Read “Bull Market Not Over, but a Correction May Be on the Horizon.”)

The current 23% correction in the Nikkei 225 would be ideal here, but I doubt that will happen, as the Japanese stock market was way overextended and due for a setback.

When I asked my friend what kind of adjustment he was looking for, to my surprise, he responded that he was not really sure and would need to evaluate the situation at that time.

Yet by the time our second bottle of wine arrived, he was more open to questions; he suggested he would need to see a correction of at least 10% before making the jump.

Of course, my friend also added that a market correction of seven percent would suffice if the Federal Reserve decided to hold tight for the third quarter, beginning to ease off on its bond buying in the fourth quarter instead.

Like the rest of the investment world, while my friend was somewhat pleased with the economic renewal in the U.S., he was also less than enthused about the jobs market and was fearful that Federal Reserve Chairman Ben Bernanke would cut stimulus sooner—or at least before his third term is over at year-end.

By the time dessert had arrived, we were both on the same page and agreed that the global stock markets were clearly driven in large part by the monetary stimulus.

He also was beginning to add some hedging to his portfolio in the way of put options and was writing covered calls to generate premium income in case the stock market stalled.

It was a great dinner. And what I learned about the stock market was not a surprise; in fact, it is likely shared by many in the investment community who are running professional money.

The U.S. Census Bureau has reported that retail and food services sales for the month of May, adjusted for seasonal effects, increased 0.6% from April and 4.3% from the same period a year ago.(Source: U.S. Census Bureau, June 13, 2013.) This is the first report I’ve seen in a long time that shows increasing consumer spending in the U.S. economy.

And the Thomson Reuters/University of Michigan Consumer Confidence Index for May showed consumer spending increasing as well. The index registered at 84.5 in May, improving from 76.4 in April. (Source: Bloomberg, May 31, 2013.) This was the highest level the index has been at since July of 2007.

While this is all good news, my concerns about the U.S. economy remain…

Since the financial crisis in the U.S. economy, the Federal Reserve has been increasing the size of its balance sheet (printing trillions of dollars in new money) and the U.S. government has been spending rigorously, all for the sake of spurring economic growth. Consumer spending in the U.S. economy makes up 70% of our gross domestic product (GDP); hence, it’s vitally important that consumer spending rises if we are to have a sustainable economic recovery.

As it stands, the Federal Reserve is still creating $85.0 billion a month in new money to purchase government bonds and mortgage-backed securities. This may be the biggest reason why economic numbers like May’s retail sales are looking better.

But the unemployment rate in the U.S. economy is still staggeringly high. According to the most recent jobs market report, there are almost 12 million people who are jobless in the U.S. economy; more than 15% of the U.S. population is on some form of food stamps, and that number has been increasing at a serious pace.

Last but not least, there are still millions of Americans in the U.S. economy who are living in a house with negative equity—their house is worth less than the loan on their home.

The minor “pop” we are seeing for some U.S. economic numbers could turn in the wrong direction very quickly. Troubles from the global economy will eventually move into the U.S. economy. Retail sales and consumer confidence increasing is certainly a step in the right direction, but I wouldn’t break out the champagne yet.

What He Said:

“Interest rates at a 40-year low: The Fed has made borrowing as easy as possible, resulting in a huge appetite for loans and mortgages. We are nearing a debt crisis.” Michael Lombardi in Profit Confidential, April 8, 2004. Michael first started warning about the negative repercussions of then Fed Governor Greenspan’s low interest rate policy when the Fed first dropped interest rates to one percent in 2004.

Not so long ago, the Congressional Budget Office (CBO) said it expected the U.S. government to register a budget deficit in the current fiscal year of $642 billion.

But hold on a minute…

The budget deficit so far (as of May 31, 2013) has already hit $626.3 billion, and we still have four more months to go in the government’s current fiscal year!

Since the beginning of the U.S. government’s current fiscal year 2013, which began in October of last year, the government has posted a budget deficit in six out of the past eight months.

The Department of the Treasury just reported the U.S. government registered a budget deficit of $139 billion for the month of May. The federal government took in $197 billion and paid out $336 billion for the month. (Source: Department of the Treasury Financial Management Service, June 12, 2013.)

Comparing it to last year, May 2013’s budget deficit was 11% higher than that of May 2012.

The government has been raking in a budget deficit of over one trillion dollars in each of the last four years; and with four months still left in this fiscal year, it wouldn’t surprise me to see us register a fifth consecutive year of trillion-dollar-plus deficits, despite being repeatedly told by politicians that our budget deficit this year would come in under $800 billion.

This is troubling news; the more budget deficits the U.S. government registers, the more the national debt will increase, and the more the government will need to borrow to pay for expenses. It’s that simple.

Currently, our national debt stands at $16.9 trillion. (Source: www.investmentcontrarians.com, last accessed June 14, 2013.)

The ratio of the U.S. national debt to the gross domestic product (GDP) of the U.S. economy is close to 110% percent. This means that we owe more than what we produce in one year.

The chart below shows a gruesome picture of our national debt compared to U.S. GDP. Notice the rate of change since 2008—it is skyrocketing.

Chart copyright Lombardi Publishing Corporation, 2013;
Data source: Federal Reserve Bank of St. Louis, June 14, 2013.

The U.S. has been the family that spends more than it earns for many years now. In the short term, spending more than one takes in can work (especially if the Fed just prints new money and gives it to the government to pay its bills). But in the long term, if fundamental changes are not made to the government’s spending habits, financial chaos just starts all over again.

Posting a budget deficit year after year is not sustainable. The debt-infested eurozone nations did very much the same; they borrowed to spend. Look where they are now.

Michael’s Personal Notes:

Finally, some good economic news is coming to the U.S. economy…

The U.S. Census Bureau has reported that retail and food services sales for the month of May, adjusted for seasonal effects, increased 0.6% from April and 4.3% from the same period a year ago.(Source: U.S. Census Bureau, June 13, 2013.) This is the first report I’ve seen in a long time that shows increasing consumer spending in the U.S. economy.

And the Thomson Reuters/University of Michigan Consumer Confidence Index for May showed consumer spending increasing as well. The index registered at 84.5 in May, improving from 76.4 in April. (Source: Bloomberg, May 31, 2013.) This was the highest level the index has been at since July of 2007.

While this is all good news, my concerns about the U.S. economy remain…

Since the financial crisis in the U.S. economy, the Federal Reserve has been increasing the size of its balance sheet (printing trillions of dollars in new money) and the U.S. government has been spending rigorously, all for the sake of spurring economic growth. Consumer spending in the U.S. economy makes up 70% of our gross domestic product (GDP); hence, it’s vitally important that consumer spending rises if we are to have a sustainable economic recovery.

As it stands, the Federal Reserve is still creating $85.0 billion a month in new money to purchase government bonds and mortgage-backed securities. This may be the biggest reason why economic numbers like May’s retail sales are looking better.

But the unemployment rate in the U.S. economy is still staggeringly high. According to the most recent jobs market report, there are almost 12 million people who are jobless in the U.S. economy; more than 15% of the U.S. population is on some form of food stamps, and that number has been increasing at a serious pace.

Last but not least, there are still millions of Americans in the U.S. economy who are living in a house with negative equity—their house is worth less than the loan on their home.

The minor “pop” we are seeing for some U.S. economic numbers could turn in the wrong direction very quickly. Troubles from the global economy will eventually move into the U.S. economy. Retail sales and consumer confidence increasing is certainly a step in the right direction, but I wouldn’t break out the champagne yet.

What He Said:

“Interest rates at a 40-year low: The Fed has made borrowing as easy as possible, resulting in a huge appetite for loans and mortgages. We are nearing a debt crisis.” Michael Lombardi in Profit Confidential, April 8, 2004. Michael first started warning about the negative repercussions of then Fed Governor Greenspan’s low interest rate policy when the Fed first dropped interest rates to one percent in 2004.

Speculation regarding what the Federal Reserve is going to do about quantitative easing and the lull between earnings seasons are definitely factors.

There is always equity market uncertainty in the weeks before the end of a quarter (though the Dow Jones industrials have held up well). Investor sentiment reflects the collective ambiguity of whether earnings will hold up. In a sense, there’s not enough data to keep equity market speculators happy with their bets. When speculators can’t justify their positions, capital markets get cranky.

Both gold and oil prices have been bouncing off the weaker U.S. dollar. There’s always churn before a quarter ends.

I repeat my view that an equity market sell-off could occur at any time and that investors who are long should not be surprised by some pronounced downside (I wouldn’t sell Dow Jones blue chips).

The correction that both Wall Street and many investors expected did not transpire. The willingness of institutional investors to be buyers has been robust.

The equity market was led this year by a pronounced breakout in blue chips and components of the Dow Jones Transportation Average. It’s still very much worth following these companies and transportation stocks for overall market direction.

The Dow Jones Transportation Average is well off its high of 6,568.41, and this is meaningful. The retrenchment, while well deserved, is a sign that the rest of the equity market is ahead of itself.

Alaska Air Group, Inc. (NYSE/ALK) is down markedly (over 10 points) from its recent high of $68.00. This meaningful pullback is representative of what I consider fair game for the equity market on the whole and is just one more slight bit of evidence favoring a correction.

Following transportation stocks for the market’s overall direction is old school for sure, but I still think it’s worth doing. I’d like to see the transportation index stay above 6,000 for the medium-term health of this market, but if there is to be a pullback, 6,000 is an easy target.

The Dow Jones Utility Average has also blasted higher since January, but it began its retrenchment before transportation stocks. This index is down about 12% from its peak and components were fully priced.

The Dow Jones Industrial Average itself is only down slightly from its high, and this illustrates the zeal that big investors have for owning the equity market’s safest names. (See “Big Investors Still Buying Big-Caps; Will They Be Right?”)

On the cusp of a new earnings season, the choppy trading action in all capital markets should continue until corporations report or there’s news from the Fed.

It does matter if the Dow Jones utilities and transports don’t turn back upward; they are now foreshadowing retrenchment.

Significant caution remains appropriate, and I would not be buying the equity market before solid confirmation from earnings reports.

Now the economy is also on the mend; albeit, it has largely been driven by the lure of easy money. Yet growth is growth. At this juncture, the growth, while somewhat muted, is there.

Cyclical stocks are faring well and will continue to do so as long as the economy continues to grow. These companies include the likes of General Electric Company (NYSE/GE), Schlumberger Limited (NYSE/SLB), and Cisco Systems, Inc. (NASDAQ/CSCO).

Yet to make the real big gains and increase the overall return of your portfolio, small-cap stocks are the place to have some of your capital working. The small-cap Russell 2000 index is leading the pack so far in 2013, up a healthy 16.25% as of Wednesday.

The reason is that small companies tend to perform well out of a recession and during economic growth.

The stock market has been seeing some shifting of capital into defensive dividend-paying stocks (read “Investors Down-Shift Risk, Search for Safety Ongoing Theme for 2013”), but small-caps delivered their top gains in the months of January, March, May, and, so far, June.

And my feeling is that as long as the economy grows, small-caps will outperform.

Take a look at the chart of the Russell 2000 index below. The index broke north, as shown by the purple oval, out of the bullish ascending triangle. A bullish “golden cross” is firmly in place, based on my technical analysis.

Chart courtesy of www.StockCharts.com

We know that the key to stock market success is to make sure there’s ample diversification in your investment strategy as far as sectors and market caps.

Small-cap stocks entail added risk, but the reward is what could really pay off for your portfolio as far as the total expected return.

If you have too many small-cap stocks, you leave yourself open to excess selling if the market turns lower due to the high beta of small-cap stocks.

You want a good balance and you need to have patience.

I favor small-cap stocks for long-term growth as the valuations tend to be more attractive and worth a look for aggressive investors.

And while the buying of large-cap stocks will always be an integral part of your portfolio, I suggest for added overall portfolio returns, add some small-cap stocks.

Also keep in mind that reward is not without risk, but in my view, small-cap stocks are still attractive and could offer large returns if the economy and easy money continue to expand.

Home prices are still significantly lower than what they were during 2005 and 2006. On its own, there is no housing market recovery. All we are witnessing is the mere reflection of easy money provided by our central bank.

As I often write, to see a real recovery in the housing market, we need to see first-time home buyers active in the market. Unfortunately, they are not involved.

In April, first-time home buyers accounted for only 29% of all existing home purchases in the U.S. housing market. This was three percent lower than the previous month and 17% lower than April 2012, when first-time home buyers accounted for 35% of all home purchases. (Source: National Association of Realtors, May 22, 2013.)

According to a survey by Fannie Mae, last month, 40% of Americans said it’s a good time for them to sell their home. In April, the survey showed only 30% thought the same thing, and in the same period a year ago, this number stood at 16%. (Source: Realtor Magazine, June 11, 2013.) Hence, we are going to see more listings hit the housing market.

The inventory of homes for sale in the U.S. housing market increased four percent in April from the previous month nationally, but what’s troubling is that in a few areas, such as Stockton and Sacramento, California, new listings have surged 75% from a month earlier.

The basic concept of economics: when demand declines and supply increases, prices go down.

And the most common mortgage in the housing market is seeing rates tick higher. The Bankrate.com U.S. home mortgage 30-year fixed national average has skyrocketed since the beginning of May to 4.14%. While this is still historically low, it’s the highest rate in at least a year. (Source: Bloomberg, June 11, 2013.) Mortgage rates rising mean more costs are put on home buyers.

The housing affordability index (a measure that shows how affordable a mortgage is to home buyers) has declined 13% since the beginning of the year. (Source: Federal Reserve Bank of St. Louis web site, last accessed June 12, 2013.)

Taking all this into consideration—first-time home buyers absent from the housing market, the rising number of homes on the market, mortgage rates climbing higher, and housing affordability squeezing—the news for the housing market is not good.

All of a sudden, the housing market that was propped up by institutional investors’ buying seems to be running out of juice.

As a matter of fact, if the Federal Reserve ever takes the punch bowl away from the party (that being the artificially low interest rates and paper money printing) only then will we see how pathetic the housing market really is.

Michael’s Personal Notes:

My advice: if you want to know what’s happening in the global economy, do not look to the key stock indices. They are misguiding investors into believing all is well, while the global economy stands on the verge of an economic slowdown.

In these pages, I have written about major economic hubs in the global economy, namely China, Germany, and France, going through an economic slowdown. But now the smaller countries are flashing warning signs as well.

India grew at the slowest pace in a decade in its fiscal year (ended March 31, 2013). The Central Statistical Office reported that production in India at factories, in utilities, and at mines only increased by two percent in April from a year ago. In March, it increased 3.4%. (Source: Bloomberg, June 12, 2013.)

The troubles for the global economy don’t end there.

In April, Malaysia reported its trade surplus fell to the lowest level since 1997. The country’s exports to the global economy surprisingly declined 3.3% from a year ago. There are now fears that Malaysia can very well run its first trade deficit in 16 years. (Source: Reuters, June 12, 2013.)

Exports from the Philippines fell 12.8% in April from a year ago. Indonesia has been witnessing an export slump for 13 consecutive months and recorded a trade deficit in April.

In the other parts of the global economy, the situation is similar.

We have no further to look than exports of iron ore from Brazil to China. In terms of tonnage, in 2012, Brazil exported 170 metric tons of iron ore to China, three percent higher than the previous year. But in terms of value, iron ore exports to China from Brazil were $14.9 billion in 2012 compared to $19.8 billion in 2011. (Source: Shanghai Metals Market, May 30, 2013.)

The chart below of the Baltic Dry Index (BDI) is a good indicator of demand in the global economy.

 Chart courtesy of www.StockCharts.com

The BDI has been declining since the beginning of 2012, suggesting demand in the global economy is bleak.

As the optimism of stock advisors rises, I’m keeping a keen eye on the weakening global economy.

Where the Market Stands; Where It’s Headed:

This morning we woke up to the news that the Japanese stock market fell 6.3% overnight. Japan’s stock market boomed as the country’s debt-to-gross domestic product (GDP) ratio hit 200% and the Japanese central bank printed an enormous amount of new money to spur the economy. Sound familiar?

Now, Japan’s stock market is falling like a rock as people figure out the economy was never really improving. Money printing and artificially low interests rates masked the true economic picture—the same thing that will happen here.

What He Said:

“I’ve been pushing gold bullion and gold shares for over a year now. Bank in January 2002, I personally started buying gold shares.” Michael Lombardi in Profit Confidential, December 13, 2002. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.

In these pages, I have written about major economic hubs in the global economy, namely China, Germany, and France, going through an economic slowdown. But now the smaller countries are flashing warning signs as well.

India grew at the slowest pace in a decade in its fiscal year (ended March 31, 2013). The Central Statistical Office reported that production in India at factories, in utilities, and at mines only increased by two percent in April from a year ago. In March, it increased 3.4%. (Source: Bloomberg, June 12, 2013.)

The troubles for the global economy don’t end there.

In April, Malaysia reported its trade surplus fell to the lowest level since 1997. The country’s exports to the global economy surprisingly declined 3.3% from a year ago. There are now fears that Malaysia can very well run its first trade deficit in 16 years. (Source: Reuters, June 12, 2013.)

Exports from the Philippines fell 12.8% in April from a year ago. Indonesia has been witnessing an export slump for 13 consecutive months and recorded a trade deficit in April.

In the other parts of the global economy, the situation is similar.

We have no further to look than exports of iron ore from Brazil to China. In terms of tonnage, in 2012, Brazil exported 170 metric tons of iron ore to China, three percent higher than the previous year. But in terms of value, iron ore exports to China from Brazil were $14.9 billion in 2012 compared to $19.8 billion in 2011. (Source: Shanghai Metals Market, May 30, 2013.)

The chart below of the Baltic Dry Index (BDI) is a good indicator of demand in the global economy.

Chart courtesy of www.StockCharts.com

The BDI has been declining since the beginning of 2012, suggesting demand in the global economy is bleak.

As the optimism of stock advisors rises, I’m keeping a keen eye on the weakening global economy.

Where the Market Stands; Where It’s Headed:

This morning we woke up to the news that the Japanese stock market fell 6.3% overnight. Japan’s stock market boomed as the country’s debt-to-gross domestic product (GDP) ratio hit 200% and the Japanese central bank printed an enormous amount of new money to spur the economy. Sound familiar?

Now, Japan’s stock market is falling like a rock as people figure out the economy was never really improving. Money printing and artificially low interests rates masked the true economic picture—the same thing that will happen here.

What He Said:

“I’ve been pushing gold bullion and gold shares for over a year now. Bank in January 2002, I personally started buying gold shares.” Michael Lombardi in Profit Confidential, December 13, 2002. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.

Earnings estimates for the second quarter are actually being trimmed by corporations and Wall Street. It makes for a genuinely peculiar environment for the stock market—share prices at their highs on declining expectations for corporate earnings.

The lesson is clear: it doesn’t pay to fight the Fed.

Being a leading indicator, the stock market went up after employment numbers came in just slightly below consensus last week. Share prices going up on bad or weaker-than-expected economic news is powerful.

This has been going on for a number of months now. Even on days when equities open lower based on weak economic data or on technical metrics, the market has often fought its way back up.

The powerful stock market action since the beginning of the year has been a combination of renewed confidence, relative monetary certainty, the slow investment of new cash inflows, and good corporate health (strong balance sheets and solid earnings maintenance). (See “Stock Market Fake-Out: Where Is the Retrenchment?”)

But with the stock market now gyrating on the end of quantitative easing, it is distracted until second-quarter earnings season begins.

A massive stock market pullback is due anytime. Expect it. Be prepared for it. Equities have been due for a significant retrenchment for months.

The fact that stocks didn’t sell off during first-quarter earnings season really surprised me. It increases the likelihood that institutional investors will use this as the catalyst to book profits during or right after second-quarter earnings season.

Monetary policy will always be the great arbiter for the stock market. It is the most powerful catalyst for price changes. But after the Federal Reserve’s actions come earnings, and companies do have to perform in this area.

I continue to view the equity market as being very high-risk for new positions, recognizing that there are very few other asset classes for long-term investors to consider.

In each of the last three years, the stock market has taken a meaningful break over the summer months. It feels stretched and a repeat of previous summer performances is definitely in the cards.

I think the investment community itself is very surprised by the strength and fervor that institutional investors have bought this market. The earnings picture doesn’t particularly support a rising stock market. While it is true that valuations remain historically reasonable and corporations have done a good job improving their balance sheets, the lack of momentum in earnings growth and revenues over the last number of quarters is at odds with historical sentiment.

The stock market is due for everything—a down quarter, a major two- or three-day crash, and a massive correction. The system has earned it.

With big traders speculating on global monetary stimulus, fund managers are paid to play and are still nibbling.

But there definitely is pronounced fatigue apparent in the equity market now. As well, second-quarter earnings expectations are looking tired.

Capital markets are now searching for the equity correction. All that’s required is enough of a push and the sell button will be switched to “on.”

The entertainment console market is getting set to welcome the new “Xbox One” by Microsoft Corporation (NASDAQ/MSFT) and the “PlayStation 4” (PS4) by Sony Corporation (NYSE/SNE).

I just received an e-mail from Best Buy Co., Inc. (NYSE/BBY) to pre-buy the Xbox One for $499.00. I was going to pull the trigger on that deal—until Sony announced it would be selling its PS4 for $399.00. So, while I like my current Xbox over the current PS3, the $100.00 price difference will make consumers, especially those who favor the Xbox, think hard about whether to switch or remain loyal to Microsoft.

Of course, Microsoft could decide to cut its price to make sure it can retain its spot as the top seller of entertainment consoles. Or what I think could happen is that Microsoft may offer some sort of bundling deal that will see the buyer of the Xbox One get some freebies, which is always a good idea when new consoles are launched.

In addition to the console market, the videogame developers will also see a huge boost in their sales, as is generally the case when new consoles are introduced.

What will be interesting are the sales of games online via the console, which have been picking up. The sales of downloaded content and digital games increased 33% year-over-year in the United States and Europe. The key regions for online sales are the U.S., the United Kingdom, France, and Germany, which, when combined, accounted for $10.0 billion in sales in 2012, according to the NPD Group. (Source: Garcia, L., “Digital Video Game Market Growing Across The World,” Gameinformer, April 1, 2013, last accessed June 12, 2013.)

The rise in online digital sales is why companies like Microsoft and Sony are developing advanced consoles that easily allow the buying of content via the Internet. The money is made more through the content purchased via the consoles, and less on the sale of the console. This is why Sony is coming in with a cheaper console, as the company realizes that the money is in the games, movies, music, and other content purchased. Once a company sells its console, there are then expectations of associated revenue streams coming down the line—with its smaller price tag, Sony is hoping to boost console sales.

Just take a look at the new consoles and note the expanding marketplace where you can spend your dollars. You can even buy cards in stores for monetary use on the Microsoft Xbox and Sony PS systems to purchase games in the online marketplace.

So it’s going to be interesting to see how Microsoft reacts to the lower price for the PS4. You know something will happen, as Microsoft doesn’t want to lose out to Sony. (Read “Has Microsoft Found Its Savior?”)

First and most important, the strongest nations in the eurozone are experiencing an economic slowdown now too. As I have written before, France and Germany are seeing diminishing demand.

Finland, one of the financially strongest nations in the eurozone, fell into a recession in the first quarter of this year. Why? Exports from Finland are declining due to economic slowdown in the eurozone area, unemployment is increasing, and the government has introduced spending cuts. (Source: Wall Street Journal, June 5, 2013.)

The European Central Bank (ECB) expects the eurozone economy to shrink by 0.6% this year, lower than its previous estimate of 0.5%. In the first quarter of 2013, the eurozone experienced its sixth consecutive economic slowdown. (Source: Associated Press, June 6, 2013.)

Regardless of what you hear or don’t hear in the popular media, don’t believe for a second that the economic slowdown in the eurozone is going away anytime soon. The region is struggling with extreme levels of unemployment—the highest ever just recorded in April.

Some countries in the eurozone such as Ireland, Greece, and Portugal have now reached debt-to-income ratios (what the government spends compared to what the government brings in) above 300%. (Source: The Guardian, June 9, 2013.)

We have heard the head of the ECB say that the central bank will do “whatever it takes” to save the eurozone. But Germany is challenging this notion. The President of Germany’s central bank is expected to testify in front of the court and say it is illegal to bail out bankrupt eurozone countries; it puts no limit on the country’s spending and it’s essentially a way to give loans to governments of other countries. (Source: BBC News, June 11, 2013.)

You need to keep in mind that Germany was at the forefront when it was trying to help the eurozone after the debt crisis hit, sending the eurozone into a downward spiral; if Germany backs away from this “whatever it takes” stance, the outcome will not be good.

The eurozone’s economic slowdown is very important to observe, because it affects us here at home—in the profits of American companies and their stock prices.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in Profit Confidential, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.

This may be good news to the politicians who continue to believe there is an economic recovery in the U.S. economy, but it’s not enough to convince me.

In March, 47.7 million Americans, or 23.1 million households, were on some form of food stamps in the U.S. economy. (Source: United States Department of Agriculture, June 7, 2013.) This is more than 15% of the U.S. population.

And instead of people moving away from the government’s help, as would be the case during economic growth and a recovery, dependence on the government is actually increasing. Food stamp use in the U.S. economy was lower at 44.5 million in March of 2011.

Economic growth in the U.S. economy means job creation and consumers increasing spending—we have the exact opposite today.

After 2009, we had a sense of economic growth in the U.S. economy as demand in the global economy meant many multinational American companies were able to sell their goods for a profit outside the U.S. But as the global economy struggles now, it’s a different story.

For the second quarter of 2013, 116 companies in the S&P 500 have provided corporate earnings guidance; 93 of them have provided negative guidance. The ratio of companies providing negative guidance compared to companies providing positive guidance has hit the highest level since the first quarter of 2001! (Source: Thomson Reuters Alpha Now, June 10, 2013.)

Going back to Standard & Poor’s keeping the U.S. economy’s credit rating unchanged…it doesn’t mean much. We are far away from economic growth, and the troubles in the global economy continue to be a major hurdle.

American companies have plenty of cash on hand; but because they hold a very gloomy view of the U.S. economy, they are shying away from spending their money. So instead of our economy recovering on its own, we have money printing and government spending trying to help our situation—both of which failed miserably for the Japanese economy.

Michael’s Personal Notes:

I can’t stress this enough: troubles in the eurozone are far from over.

First and most important, the strongest nations in the eurozone are experiencing an economic slowdown now too. As I have written before, France and Germany are seeing diminishing demand.

Finland, one of the financially strongest nations in the eurozone, fell into a recession in the first quarter of this year. Why? Exports from Finland are declining due to economic slowdown in the eurozone area, unemployment is increasing, and the government has introduced spending cuts. (Source: Wall Street Journal, June 5, 2013.)

The European Central Bank (ECB) expects the eurozone economy to shrink by 0.6% this year, lower than its previous estimate of 0.5%. In the first quarter of 2013, the eurozone experienced its sixth consecutive economic slowdown. (Source: Associated Press, June 6, 2013.)

Regardless of what you hear or don’t hear in the popular media, don’t believe for a second that the economic slowdown in the eurozone is going away anytime soon. The region is struggling with extreme levels of unemployment—the highest ever just recorded in April.

Some countries in the eurozone such as Ireland, Greece, and Portugal have now reached debt-to-income ratios (what the government spends compared to what the government brings in) above 300%. (Source: The Guardian, June 9, 2013.)

We have heard the head of the ECB say that the central bank will do “whatever it takes” to save the eurozone. But Germany is challenging this notion. The President of Germany’s central bank is expected to testify in front of the court and say it is illegal to bail out bankrupt eurozone countries; it puts no limit on the country’s spending and it’s essentially a way to give loans to governments of other countries. (Source: BBC News, June 11, 2013.)

You need to keep in mind that Germany was at the forefront when it was trying to help the eurozone after the debt crisis hit, sending the eurozone into a downward spiral; if Germany backs away from this “whatever it takes” stance, the outcome will not be good.

The eurozone’s economic slowdown is very important to observe, because it affects us here at home—in the profits of American companies and their stock prices.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in Profit Confidential, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.

The Great Reflation is a non-political, historical breakdown of inflation, monetary and fiscal policies, interest rates, and long-wave economic theory. It was completed in 2010 and made several predictions on the U.S. economy that have turned out to be correct so far.

Boeckh, former publisher of the Bank Credit Analyst, delves into past financial manias, asset inflation bubbles, asset allocation for the aftermath, the U.S. dollar decline, commodities, and the monetary future of the stock market and the U.S. economy.

Here is a summation of Boeckh’s observations:

1. The global financial system will always remain flawed and subject to price inflation and bubbles, so long as it is based on fiat paper money.

2. Before 1914, most Western countries had a monetary regime that legally restricted central bank money creation based on its holdings of gold.

3. Average interest rates fell throughout the 100 years leading up to 1914.

4. In the absence of a financial system based on discipline and restraint, all anchorless fiat money systems (especially the U.S. economy) are destined to suffer inflation and instability.

5. Investors will be playing cat-and-mouse with the Federal Reserve for years to come—a problem caused by excessive private and public debt.

6. Deleveraging of the private sector bodes well for the transition process to the next long-wave cycle (2015+).

7. If the U.S. economy can’t help reduce the debt-to-gross domestic product (GDP) ratio in a timely manner, investors will face a public-sector debt supercycle larger than the post-1982 private-sector supercycle.

8. In the short term, deficits and extreme monetary expansion help the private sector repair balance sheets, but they cannot raise the standard of living for the average person.

9. The real total return of the S&P 500, deflated for inflation, is remarkably consistent over a long period of time.

10. Tactical asset allocation is the key to wealth creation and capital preservation.

11. In a world of economic fragility, investors want stability in the U.S. dollar, but the long-term outlook is bearish.

12. Gold is a crowded trade, but it’s useful as an insurance/inflation hedge in portfolios. Gold is an emotional purchase. Financial/investment demand for gold differs greatly from consumption.

13. Long-term returns from commodities as an asset class are unreliable and they trade in manias.

14. Historically, rising fiscal burdens hasten the demise of empires. The U.S. economy can chart a positive new path, but only with the removal of the political stalemate of vested interests.

15. There will likely not be any effective reform of the global monetary system anytime soon. Greater price inflation is coming.

16. The stock market has proven it does well following long-wave troughs after major financial crises.

17. The long run in this investment world no longer exists. Wealth preservation and portfolio safety are critical.

18. The music has started playing again, but there aren’t enough chairs for when it stops.

The Great Reflation is a very thoughtful historical look at the long-run economic cycles experienced by the U.S. economy. (See “Equity Flux: The Stock Market’s Latest Problem.”)

The U.S. economy has been consistently swept away by asset bubbles and financial crises, and Boeckh clearly demonstrates how monetary policy so powerfully influences cycles with changes in interest rates and price inflation.

Looking at the data and tables presented, the inflation-adjusted long-term uptrend in the stock market (since 1929, including dividends) averages just under seven percent annually. This is littered with long periods of extreme undervaluation and overvaluation.

Boeckh’s best advice is to employ “tactical stock market reallocation” to continually adjust your exposure to equities as monetary policy perpetually changes the inflation/deflation cycles experienced by the U.S. economy.

In fact, I often will screen stocks based on my technical analysis system, and from there, I’ll take a closer look at the company’s underlying fundamentals. But the strategy I use for day trading and swing trading differ from the process I employ for longer-term buys.

For trading, I tend to rely on technical analysis more than I do for longer-term investments.

Stocks that I really like to look at are those trading at their 52-week highs. (Read “Denny’s Serves Up Grand-Slam Returns.”) Some of you might ask why I would bother to look at stocks that have already eclipsed their 52-week highs. The reason is that these stocks are trading at their highs, because they are delivering results to Wall Street. As a side note, I also look at stocks near their lows, but these are predominately viewed as contrarian picks.

An excellent example of a stock at a 52-week high that I suggested readers keep on their watch lists recently was Mannkind Corporation (NASDAQ/MNKD), a biopharmaceutical company that is making some great strides in developing therapeutic products for several diseases, including diabetes, cancer, and inflammatory and autoimmune diseases.

On the chart, Mannkind has made 26 new highs this year and has shot up 213% in that time, according to data from Barchart.com. Over the past year, the stock made 32 new highs and is up a sizzling 341%, based on my technical analysis.

Examining Mannkind’s stock chart through technical analysis, the company is excellent, showing successive highs this year, as indicated by the purple circle in the chart below.

The stock is pausing now, down eight percent from its high, so it may be taking a break. I would not be chasing the stock as the easy money has been made for now, based on my technical analysis.

Chart courtesy of www.StockCharts.com

In addition to Mannkind, there is always a good buying opportunity to make money when examining stocks trading at their 52-week highs through technical analysis.

I look for high volume stocks trading above their 50- and 200-day moving averages (MAs). You want to look for a possible “golden cross” pattern, in which the 50-day MA is above the 200-day MA, as shown in the chart of Mannkind below. You also want to see strong or rising relative strength and a bullish moving average convergence/divergence (MACD).

Chart courtesy of www.StockCharts.com

Another stock on the rise is Novatel Wireless, Inc. (NASDAQ/NVTL), which jumped 7.71% on June 7 and is edging higher on the chart.

Chart courtesy of www.StockCharts.com

Other potential candidates include MicroVision, Inc (NASDAQ/MVIS), Pacific Sunwear of California, Inc. (NASDAQ/PSUN), Flamel Technologies S.A. (NASDAQ/FLML), and TearLab Corporation (NASDAQ/TEAR).

The second-biggest economy in the world is sending out warning signals, but no one seems to care.

Statistics clearly show the Chinese economy is witnessing an economic slowdown. I warn you that its implications will be massive for the global economy and the U.S. economy.

Last month, exports from the Chinese economy increased only one percent from a year ago, while economists were predicting an increase of seven percent—very disappointing for the Chinese economy. (Source: New York Times, June 8, 2013.)

Adding to the misery, it wasn’t too long ago when the credit rating of the Chinese economy was downgraded by Fitch Rating Services from AA- to A+ (investment grade with some risk). At the time, Fitch said that the Chinese economy had “underlying structural weaknesses.” Credit in the country has reached 198% of gross domestic product (GDP). Back in 2008, it stood at 125%. (Source: “Fitch Downgrades China’s Credit Rating,” Financial Times, April 9, 2013.)

Bringing all of this into perspective, if the economic slowdown in the Chinese economy persists, we will see commodities prices decline further, because Chinese companies are such big consumers of commodities. For example, copper prices are already down more than 10% since the beginning of the year. As a result, companies in the basic material, industrial, and energy sectors will see their profitability decline.

It’s common sense: if an industrial metal company is able to take copper out of the ground for $3.00 per pound, and sells it for $3.60, then it will be able to reap rewards of more than 20%. But if copper prices go down to $3.30 (or about 10%), the company’s profitability declines by half!

Combined, companies in the energy, industrial, and material sectors make up little more than 24% of the S&P 500. (Source: Standard and Poor’s web site, last accessed June 10, 2013.) The economic slowdown in the Chinese economy can make one-quarter of the S&P 500 companies vulnerable, impacting the stock market.

As it stands, stock market euphoria is rampant—the key stock indices are moving ahead of reality. But the panic will strike once again, and the wealth of those who are extensively buying stock today will suffer. Be careful, dear reader. The economic slowdown in the Chinese economy will eventually take its toll on many American multinational companies and their stock prices.

West Texas Intermediate (WTI) crude is getting awfully close to the $100.00-per-barrel level again. Futures traders are interpreting economic news, including last Friday’s employment report, as strength in the U.S economy.

Resource stocks have generally been trending lower, particularly in precious metals. But this hasn’t been the case with the oil stocks, especially large-cap integrated oil companies. They continue to do relatively well on the stock market even though the spot price of oil has been mostly flat until just recently.

From a business perspective, virtually any equity market portfolio is well served by having some exposure to oil stocks (environmentalists may disagree).

The last time we considered Chevron Corporation (NYSE/CVX), the position was trading around $117.00 a share. It’s currently around $121.00, having pulled back from a new stock market high of $127.40. The stock is currently yielding 3.3%.

Stock market strength among big oil stocks is pretty impressive with oil prices just under $100.00 a barrel and natural gas prices still in a long consolidation.

ConocoPhillips (NYSE/COP) is holding up extremely well, especially after spinning off Phillips 66 (NYSE/PSX), which has been an outstanding oil stock since the divestiture. Adjusted first-quarter earnings for ConocoPhillips were basically flat comparatively. The stock is currently yielding 4.3%.

Crude oil inventories in the U.S. market recently hit an 82-year high (due to all the new production). Data shows that inventories have been drawn down over the last couple of weeks.

In many ways, oil prices are also trading off the Federal Reserve.

Right now, Chevron is toying with its 50-day moving average (MA). The stock broke its 50-day MA back in the middle of April, then reaccelerated. The company’s long-term stock chart is featured below:

Chart courtesy of www.StockCharts.com

The equity market experiences waves of enthusiasm from different places, and for quite some time, it was trading off the action in oil prices. The fact that oil prices are now close to $100.00 a barrel again in the face of escalating domestic production is telling of the willingness of traders to bid this market. (See “The Only Way to Beat Rising Gasoline Prices.”)

The recent spike in oil prices seems to be a spin-off itself of the stock market’s enthusiasm of late. Actual supply and demand figures on oil are being attributed less weight by traders in this monetary expansion.

Second-quarter earnings estimates for big oil have been going up on presumed margin improvement.

Chevron’s 2013 first-quarter earnings were $6.2 billion, down from $6.5 billion comparatively. Revenues last quarter were $54.0 billion, down from $59.0 billion comparatively, mostly due to lower oil prices.

Chevron advanced a good $10.00 a share in the first quarter. The effects of the monetary expansion are now—without question—cajoling oil prices.

China-based shopping center LightInTheBox Holding Co., Ltd. (NASDAQ/LITB), an online seller of apparel and other household goods to the world market, is the top Chinese online retailer as far as sales to customers outside of its country’s borders. The company, sometimes seen as the little “Amazon.com” of China, was started by Alan Guo, who was previously an executive at Google China. The company priced 8.3 million shares at $9.50 (the mid-point). The deal was hot due to the absence of IPOs coming from China. The stock surged 34% to an intraday high of $12.69 prior to settling at $11.61 for a market cap of about $470 million.

The strong buying in LightInTheBox indicates the demand for Chinese IPOs that are deemed to be trustworthy. The other two Chinese IPOs that debuted in 2012 have done well—online discount retailer Vipshop Holdings Limited (NYSE/VIPS) and social media company YY Inc. (NASDAQ/YY) are up a whopping 340% and 150%, respectively, from their IPO debuts.

At issue have been the numerous cases of fraudulent financial reporting by Chinese companies listing in the U.S., since these companies were not subject to U.S. reporting requirements with many listing on the bulletin board and pink sheets.

The Securities Exchange Commission (SEC) finally had enough and decided to demand more detailed and audited reporting by Chinese companies seeking to list in the U.S.

We all know what happened after; whether the flow of Chinese IPOs will begin again for the U.S. capital markets is doubtful at this time, as there’s tons of money available in Asia. (Read “Chinese Economy Finally Slowing; What It Means for Its Stocks.”)

Goldman Sachs suggests the major market for Chinese IPOs will be at home in China, where there could be as many as 349 IPOs this year. (Source: “China: A-share Portfolio Strategy, IPO deep dive: The Sword of Damocles or Paper Tiger?,” China First Capital web site, January 23, 2013, last accessed June 10, 2013.)

Of course, the U.S. capital markets are favored by Chinese companies that want more exposure and possible access to the U.S. and other global markets for their products.

Yet based on what the SEC has said, any Chinese company looking at listing here will be subjected to stringent reporting requirements, including all of the approved U.S. “Big Four” auditors. I’m all for the move, as it will give me more confidence in buying Chinese stocks.

Based on what happened to LightInTheBox, the demand for Chinese IPOs appears to be hot. The problem will be to convince the Chinese to adhere to U.S. demands.

With over 1.3 billion people and a massive middle class, you know there are many Chinese companies that would find a nice home here.

The Finance Minister of India said last week, “Banks have a role to play in dampening the enthusiasm for gold. I think the RBI [Reserve Bank of India] has advised banks that they should not sell gold coins.” He added, “I would urge all banks to please advise their branches that they should not encourage their customers to invest in or buy gold.” (Source: “P. Chidambaram hints banks likely to stop gold coin sales to curb demand,” The Indian Express, June 7, 2013.)

The appetite for gold bullion by Indian consumers has forced its government to increase the import tax on the yellow metal to eight percent—it has increased this tax rate twice in the past six months!

But the Indian economy isn’t the only one experiencing a surge in gold demand.

The acting director of the U.S. Mint, Richard Peterson, was quoted last week saying, “Demand [for gold bullion] right now is unprecedented…” (Source: “US bullion coin demand still at unprecedented levels-US Mint Chief,” Reuters, June 5, 2013.)

Looking at the sales of gold bullion coins from the U.S. Mint, demand has more than doubled. In the first five months of this year ending in May, the U.S. Mint sold 572,000 ounces of gold bullion in coins. In the same period a year ago, the Mint sold only 283,500 ounces of gold bullion. (Source: The United States Mint web site, last accessed June 7, 2013.)

Dear reader, the numbers are speaking louder than the words. Even when there’s a significant amount of downward price pressure toward gold bullion, demand is doing the opposite and increasing sharply.

Aside from what I have written above, I still believe central banks will eventually be the major force driving gold bullion prices. Countries like Russia, Turkey, and Kazakhstan continue to add gold bullion to their reserves.

Central banks want stability in their reserves and gold bullion does the job perfectly. Just look at the chart below of the U.S. Dollar Index (which measures the value of the dollar compared to other major currencies):

Chart courtesy of www.StockCharts.com

Now ask this question: as the most conservative investors, why would central banks be willing to hold the U.S. dollar in their reserves when the Federal Reserve just keeps printing more of them? Central banks are worried about paper currencies, thus, they are looking at gold bullion again as the alternative to reserve stability.

Michael’s Personal Notes:

The Japanese economy is a prime example of what happens when central bank–infused “economic growth” crumbles.

Quantitative easing may have been needed in the U.S. economy when the financial system was on the verge of collapse, but artificially low interest rates and vast amounts of paper money printing could be creating major troubles for our future, just like it did in the Japanese economy.

The Bank of Japan and the Japanese government have taken a strong stance on bringing economic growth to the Japanese economy. The Bank of Japan has taken the concept of quantitative easing to a new level, and it plans to continue increasing the country’s money supply. Similar to what’s happening here in America, the Bank of Japan is printing new money to buy government bonds. Japan’s central bank has become heavily involved in the stock market of the Japanese economy by buying units in exchange-traded funds (ETFs) and real estate investment trusts (REITs).

Sadly, the outcomes of this rigorous quantitative easing are dismal. The Japanese economy isn’t improving. Rather, the currency of the country has become a major victim, and the stock market in the Japanese economy is bursting.

Take a look at the chart below, which shows the value of the Japanese yen (black line) declining continuously, while the stock market is rising and bursting (red/black line).

Chart courtesy of www.StockCharts.com

On May 23, the stock market in the Japanese economy took a turn downward; since then, it has been declining quickly.

When I look at this, it makes me question the stability of the key stock indices here in the U.S. economy. The Federal Reserve is still going ahead with its quantitative easing and printing $85.0 billion a month to spur economic growth. As a result of this, the stock market has risen significantly, giving investors a false idea about prosperity here in the U.S.

I still continue to be skeptical about the rise of the stock markets in the U.S. economy. Many are questioning whether the rise in American stock markets is a direct result of the Fed’s quantitative easing program.

The stock market in the Japanese economy tumbled more than 3,000 points in a matter of weeks as its bubble burst; it wouldn’t be a surprise for me to see the Dow Jones Industrial Average do the same.

What He Said:

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

Quantitative easing may have been needed in the U.S. economy when the financial system was on the verge of collapse, but artificially low interest rates and vast amounts of paper money printing could be creating major troubles for our future, just like it did in the Japanese economy.

The Bank of Japan and the Japanese government have taken a strong stance on bringing economic growth to the Japanese economy. The Bank of Japan has taken the concept of quantitative easing to a new level, and it plans to continue increasing the country’s money supply. Similar to what’s happening here in America, the Bank of Japan is printing new money to buy government bonds. Japan’s central bank has become heavily involved in the stock market of the Japanese economy by buying units in exchange-traded funds (ETFs) and real estate investment trusts (REITs).

Sadly, the outcomes of this rigorous quantitative easing are dismal. The Japanese economy isn’t improving. Rather, the currency of the country has become a major victim, and the stock market in the Japanese economy is bursting.

Take a look at the chart below, which shows the value of the Japanese yen (black line) declining continuously, while the stock market is rising and bursting (red/black line).

Chart courtesy of www.StockCharts.com

On May 23, the stock market in the Japanese economy took a turn downward; since then, it has been declining quickly.

When I look at this, it makes me question the stability of the key stock indices here in the U.S. economy. The Federal Reserve is still going ahead with its quantitative easing and printing $85.0 billion a month to spur economic growth. As a result of this, the stock market has risen significantly, giving investors a false idea about prosperity here in the U.S.

I still continue to be skeptical about the rise of the stock markets in the U.S. economy. Many are questioning whether the rise in American stock markets is a direct result of the Fed’s quantitative easing program.

The stock market in the Japanese economy tumbled more than 3,000 points in a matter of weeks as its bubble burst; it wouldn’t be a surprise for me to see the Dow Jones Industrial Average do the same.

What He Said:

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

There’s always a continuing flow of earnings reports, and one company I’ve followed for years just beat the Street again.

Earnings growth rates might not be as robust as they once were, but modest business growth is out there.

One growing company that continues to execute well is AAON, Inc. (NASDAQ/AAON) out of Tulsa, Oklahoma. This company manufactures and installs heating, ventilation, and air conditioning (HVAC) equipment for commercial and residential customers.

The company was founded in 1988 and now has approximately 1.5 million square feet of office and manufacturing facilities, with over 1,300 employees at two plants.

AAON’s first-quarter revenues grew three percent to $66.8 million, mostly based on higher prices. Earnings grew a substantial 56% to $7.1 million, or $0.29 per diluted share, compared to earnings of $4.6 million, or $0.18 per diluted share.

The company said that both its revenues and earnings made new records in the first quarter of 2013.

AAON’s cash balance tripled and the company’s backlog increased 22% to a record $71.7 million comparatively.

On top of this modest but successful business growth, the company boosted its semi-annual cash dividend by 25% and declared a new three-for-two stock split.

I like these kinds of small businesses.

AAON is a company making real products that the marketplace requires. The HVAC industry isn’t the fastest-growing sector, but AAON’s ability to grow its business in a diligent and consistent manner is demonstrable.

The company’s stock market performance is also noteworthy. AAON’s long-term stock chart is featured below:

Chart courtesy of www.StockCharts.com

With the stock market around its all-time high, I’m reticent about new positions. But there are plenty of companies out there that are worth keeping on your radar in anticipation of more attractive entry points. (See “Why You Should Add Two Medical Stocks to Your Watch List.”)

AAON is about to effect its fifth stock split since listing.

Small-cap stocks have performed similarly to blue chips. Their run-up has been pronounced.

Second-quarter earnings season is quickly approaching, and the marketplace will still bid those companies that beat consensus. Corporations have been deliberately subdued with their earnings outlooks. This has been going on for several years now, and it makes it easier to “outperform.”

Companies like AAON are worth adding to a watch list. Proven track records of business success, earnings growth, and stock market success are golden.

A company like AAON would make a welcome addition to a larger HVAC manufacturer if the company’s management wanted to cash out. AAON’s latest earnings report was solid.

Now, with home prices nationwide continuing to rise and the jobs creation picture showing signs of improvement (though it is still slogging along), the end result has been a rise in consumer spending, which has helped to drive the retail sector.

Spending on durable goods is a good indicator on how positive consumers are in the retail sector, as this spending is on nonessential goods. So when consumers spend on this group, you know there’s some confidence in the overall economy. In April, durable goods surged 3.3%, which was well above both the Briefing.com estimate calling for a 1.5% decline and the 5.9% decline in March. On an ex-transportation basis, durable goods increased 1.3%.

Retail sales edged up 0.1% in April, which was above both the Briefing.com estimate calling for a 10.7% drop and the 0.5% decline in March.

In May so far, 10 U.S. retail chains have reported, and the results have been good, with the key same-store sales surging up 3.9% versus the 3.7% estimate. (Source: Wahba, P., “Retailers’ sales rise in May, spending stays moderate,” Reuters, June 6, 2013.)

Results from the big-box stores continue to be healthy in the retail sector.

Market leader Costco Wholesale Corporation (NASDAQ/COST) reported sales growth of seven percent in May, while its key same-store sales increased by five percent.

A big surprise was delivered by American Apparel, Inc (NYSE/APP), which reported an impressive 10% surge in its same-store sales in May. (Read more on American Apparel in “A Real ‘Made in the USA’ Retail Stock That Supports Your Portfolio, Not Sweatshops.”) American Apparel remains an excellent speculative play that has moved up over 10% since my review. The best thing about this company is that its clothes are all manufactured in the U.S., which will cater to the patriotic looking for real “made in the USA” stocks.

The stock chart of the S&P Retail Index below shows the steady climb of the retail sector since the beginning of the year; the chart is also indicating that the retail sector is currently facing some stalling.

Chart courtesy of www.StockCharts.com

Much of the consumer buying has been largely due to the availability of cheap money and financing. People are saving less, given the low yields, and are spending more.

In my view, the retail sector continues to show promise, but the easy money has been made. For the aggressive trader, you need to consider contrarian retail opportunities, including bebe stores, Inc. (NASDAQ/BEBE), Chico’s FAS, Inc. (NYSE/CHS), Ascena Retail Group, Inc. (NASDAQ/ASNA), and Saks Incorporated (NYSE/SKS).

In the first quarter of 2013, hourly compensation of Americans employed in non-farm businesses fell 3.8%. This was the biggest drop since the Bureau of Labor Statistic started to measure this statistic in 1947. (Source: Bureau of Labor Statistics, June 5, 2013.)

Consumer spending is not rising as one would expect in a real economic recovery. In fact, real personal consumption expenditures (excluding food and energy) adjusted for price changes rose less than one percent in the first four months of 2013! (Source: Federal Reserve Bank of St. Louis web site, last accessed June 6, 2013.)

And inventories of businesses in the U.S. economy also paint a grim picture of consumer spending. In March, manufacturing and trade inventories stood at $1.64 trillion, up five percent from March 2012. (Source: Ibid.) In an improving economy, like the one that the majority of media outlets and politicians tell us we are in, business inventories are supposed to decline—not rise!

No, businesses building up inventories are not a good sign.

But in spite of the pressures on consumer spending, the stock prices of companies in the consumer “discretionary” sector—that’s businesses that sell nonessential goods—continue to rise.

Take a look at the chart below of the Consumer Discretionary Select Sector SPDR (NYSEArca/XLY) exchange-traded fund (ETF) to get an idea of what’s happened to the stock prices of companies that sell discretionary nonessential items to consumers.

Chart courtesy of www.StockCharts.com

 Let’s call a spade a spade: the above chart is not an indication that consumer spending is rising. It’s a chart that simply shows that the stock prices of companies that sell consumers nonessential items are rising because investors are bidding up these stocks.

Don’t let the stock market falsely tell you consumer spending in the U.S. economy is improving and that businesses are doing great, because that’s simply not the case! The reality is that the opposite is happening.

Looking at the health of the U.S. economy, it is very, very weak. This is the weakest economic recovery following a recession I have ever lived through—I believe many Americans would agree with me.

Spending by U.S. consumers makes up more than two-thirds of the U.S. gross domestic product (GDP). If consumer spending isn’t increasing, we can’t have a real economic recovery; it’s that simple, regardless of what rising stock prices may allude to.

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.

 The unemployment situation in the U.S. in May was essentially the same as in April. (I wonder how the Federal Reserve looks at this. Does it say, “Wow, imagine what would have happened to the jobs market in May if you didn’t create $85.0 billion in new money during the month”?)

 My readers know I don’t care much for the “official” unemployment numbers we get from the government statistics office. I believe the official rate doesn’t show the real picture, because it does not include people who have given up looking for work in the jobs market and people who want full-time jobs but can only find part-time jobs.

 When we take into consideration these two important figures that the official numbers leave out, the underemployment rate, as it is referred to, was 13.8% in May—it’s been hovering around 14% for years now.

 A startling 7.9 million Americans are working part-time, because they can’t find full-time work in today’s jobs market.

 In total, there are still some 12 million people in the U.S. jobs market looking for work. What’s most troubling is that 37.3% of them have been unemployed for more than six months! The longer they stay out of the jobs market, the more difficulties these people will face in finding jobs as their skills become obsolete.

 Looking closer at May’s jobs market report (which I feel was an all-round terrible report), new employment in industries like mining and logging, construction, manufacturing, wholesale trade, transportation and warehousing, and financial activities witnessed next to no change in May.

 Yes, the growth in the jobs market is in low-paying retail and service positions. We have college graduates working jobs that pay minimum wage.

 Dear reader, there is something definitely wrong with this economic recovery. The government has increased its national debt by $17.0 trillion, and the Federal Reserve’s balance sheet has grown to $3.0 trillion…and we still can’t get create jobs.

 This so-called economic recovery smells funny to me. Maybe the recovery doesn’t even exist. Take out the sucker’s rally in the stock market, and there really isn’t much left to the economy.

Michael’s Personal Notes:

How can consumer spending in the U.S. economy rise under these circumstances…

In the first quarter of 2013, hourly compensation of Americans employed in non-farm businesses fell 3.8%. This was the biggest drop since the Bureau of Labor Statistic started to measure this statistic in 1947. (Source: Bureau of Labor Statistics, June 5, 2013.)

Consumer spending is not rising as one would expect in a real economic recovery. In fact, real personal consumption expenditures (excluding food and energy) adjusted for price changes rose less than one percent in the first four months of 2013! (Source: Federal Reserve Bank of St. Louis web site, last accessed June 6, 2013.)

And inventories of businesses in the U.S. economy also paint a grim picture of consumer spending. In March, manufacturing and trade inventories stood at $1.64 trillion, up five percent from March 2012. (Source: Ibid.) In an improving economy, like the one that the majority of media outlets and politicians tell us we are in, business inventories are supposed to decline—not rise!

No, businesses building up inventories are not a good sign.

But in spite of the pressures on consumer spending, the stock prices of companies in the consumer “discretionary” sector—that’s businesses that sell nonessential goods—continue to rise.

Take a look at the chart below of the Consumer Discretionary Select Sector SPDR (NYSEArca/XLY) exchange-traded fund (ETF) to get an idea of what’s happened to the stock prices of companies that sell discretionary nonessential items to consumers.

Chart courtesy of www.StockCharts.com

 Let’s call a spade a spade: the above chart is not an indication that consumer spending is rising. It’s a chart that simply shows that the stock prices of companies that sell consumers nonessential items are rising because investors are bidding up these stocks.

Don’t let the stock market falsely tell you consumer spending in the U.S. economy is improving and that businesses are doing great, because that’s simply not the case! The reality is that the opposite is happening.

Looking at the health of the U.S. economy, it is very, very weak. This is the weakest economic recovery following a recession I have ever lived through—I believe many Americans would agree with me.

Spending by U.S. consumers makes up more than two-thirds of the U.S. gross domestic product (GDP). If consumer spending isn’t increasing, we can’t have a real economic recovery; it’s that simple, regardless of what rising stock prices may allude to.

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.

This is the kind of company that can be put into retirement accounts and held for long periods of time with dividend reinvestment.

The equity market has been very kind to PepsiCo since the beginning of this year. Like many blue chips, it has ridden a wave of enthusiasm by institutional investors looking to bid the equity market with the safest names.

PepsiCo offers safety as a corporation with an array of beverage products that are sold worldwide. The many brands that the company maintains are complemented by its snack business. The two businesses go hand-in-hand.

As a multinational company, currency translation plays a big role in its numbers. In the first quarter of 2013, organic revenue growth was a solid 4.4%, but after currency translation, this fell to a mere one percent.

The company’s Americas Foods division was the highlight, producing organic revenue growth of six percent (five percent after currency translation). PepsiCo experienced business growth in all its Americas Foods segments, which include Frito-Lay North America, Quaker Foods North America, and Latin America Foods.

PepsiCo’s first-quarter financial results beat consensus, and big investors celebrated the modest stability.

The equity market has generally been a consistent accumulator of shares in this company. Featured below is PepsiCo’s 25-year stock chart, adjusted for splits:

Chart courtesy of www.StockCharts.com

Consistent with its previous guidance for 2013, the company expects seven-percent growth in its core constant currency earnings per share this year. Combined with its dividend yield of nearly three percent, that’s a decent equity market prospect from such a mature and relatively safe corporation.

PepsiCo plans to spend $6.4 billion in dividends and share repurchases this year. With a forward price-to-earnings (P/E) ratio of around 17 and a trailing P/E of approximately 21, PepsiCo is fully priced.

This company is one of my long-term “super stocks”—great blue-chip companies that offer earnings growth, dividends, and capital preservation. (See “The Best Kind of Stock to Own for the Rest of This Decade.”)

I’m a big believer in dividend reinvestment for a long-term portfolio. While saving for retirement, you can increase your total returns significantly with automatic dividend reinvestment plans.

And once you’re retired, you can stay in the equity market if you choose and use those dividends for income.

If you bought PepsiCo in August of 2009, your simple return to date would be around 43%. With dividend reinvestment into new shares of the company, your return jumps to 60% (recognizing that 2009 was an exceptional base for the equity market).

There are plenty of super stocks out there to consider in a correction, and the soda, beverage, and snack market is a good one.

PepsiCo’s corporate outlooks and equity market returns are generally quite reliable.

And just like it was back in late 1999, there are more bulls coming out on Wall Street and saying how high the Dow could run. I have heard talk of the Dow at 20,000 and the S&P 500 at 1,800.

Then there’s the recent cheerleading on the stock market from perennial bull Jeremy Siegel from the Wharton School of business, who thinks the Dow could trade at 17,000 this year. (Source: Navarro, B.J., “Jeremy Siegel Still Sees Dow 17,000,” CNBC, May 31, 2013.)

With all of this bullishness, I’m now thinking of an exit strategy. Everyone who thinks this stock market is going higher without some sort of correction may be surprised.

The way I see it is the stock market is vulnerable to selling, but as I said a few days ago, stocks will likely end up higher by the year’s end, as long as the Fed continues to offer easy and cheap money. (Read “How the Stock Market Staged a Rally and Not a Meltdown This May.”)

Never mind the speculation surrounding the Federal Reserve cutting its bond buying at the upcoming Federal Open Market Committee (FOMC) meeting on June 14 and 15; as long as the jobs picture remains fragile, the Fed will likely refrain from doing so until there are stronger economic signals.

The ADP Employment Change was weaker than expected at 135,000 new jobs in May (source: Automatic Data Processing web site, last accessed June 6, 2013), below the Briefing.com estimate of 140,000. If the non-farm reading today also comes in subpar, then I believe the Fed may think hard about cutting stimulus at this juncture.

Of course, you also have to worry about the bubble-like situation in the Japanese stock market. Yes, I say the Nikkei is in a bubble and may be set to burst. The reality is that the benchmark Nikkei 225 is way overvalued, and it fell another 3.8% on Wednesday. With the decline, the overhyped index is now down 15.7% from its high on May 22.

Apparently, Japan’s Prime Minister and the mastermind behind the country’s massive capital injection, Shinzo Abe, failed to discuss the Japanese economy in detail at a keynote speech. Perhaps Mr. Abe has something he wants to avoid talking about.

While the Japanese situation is 10,000 miles away, the ramifications of a major sell-off there would likely trigger a correction in other global stock markets.

The bull market is not done, but I’m seeing an upcoming opportunity to accumulate stocks.

Corporate earnings are weak; we know that. So far for the second quarter of 2013, more than 80% of the companies in the S&P 500 that have issued their corporate earnings guidance have provided a negative outlook. (Source: FactSet, May 31, 2013.)

Yes, the key stock indices have gotten ahead of themselves. In the first two months of the second quarter, the S&P 500 increased five percent; but as that was happening, earnings estimates for the quarter dropped by 3.4%!

At the end of March, analysts expected the S&P 500 companies to register an increase of 4.4% in their corporate earnings for the second quarter; now that number has dropped to a paltry 1.3%. (Source: FactSet, May 31, 2013.)

In the first quarter of 2013, companies in the key stock indices struggled with revenue growth. Only 46% of the S&P 500 companies recorded revenues above estimates for the first quarter, while the average for the last four quarters was 52%.

But there are further threats to corporate earnings. Demand is weak in the U.S. economy, as the American consumer is still under pressure—he or she is typically working at a job that pays the minimum wage (that’s where most of our jobs growth has been since the Great Recession ended), while the costs of basic necessities continue to rise in an environment where the government says there is no inflation.

I remain skeptical of the rise in the key stock indices, as they aren’t moving in line with the current business conditions in the U.S. economy. I continue to believe the bear market rally, which began in 2009, has done a great job in luring investors back into the stock market. The key stock indices are up significantly and have given investors a false hope that they will climb further.

The S&P 500 has been making lower lows and lower highs since May 22 (as you can see in the chart below), but from what I’ve read from stock advisors, they say to buy on dips—advice I’m not following.

Chart courtesy of www.StockCharts.com

What’s going on with the equity markets right now reminds me of 2007 all over again—that’s when the key stock indices were moving higher, regardless of what was happening with the economy. We are experiencing something similar to that right now, with the stock market and economy having gone in such opposite directions.

Predicting the exact point at which the top will be in for the stock market is difficult, if not impossible, but odds are we are very close.

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 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.

It is very well documented in these pages how home prices in the U.S. economy are being driven upward by institutional investors. Affirming my stance on the U.S. housing market, Suzanne Mistretta, an analyst at Fitch Rating Services, was quoted this week as saying, “The [housing price] growth is being propelled by institutional money… The question is how much the change in prices really reflects the market demand, rather than one-off market shifts that may not be around in a couple of years.” (Source: Popper, N., “Behind the Rise in House Prices, Wall Street Buyers,” New York Times Dealbook, June 3, 2013.)

Major financial institutions like The Blackstone Group L.P. (NYSE/BX) have become major buyers in the U.S. housing market. Blackstone has spent more than $4.0 billion for 24,000 homes in the U.S. housing market that it plans to rent out.

Rising prices on homes in various pockets of the U.S. housing market are a direct result of large institutional investors buying in.

Take Atlanta, for example. Blackstone bought 1,400 properties worth more than $100 million in Atlanta last year. (Source: Bloomberg, April 25, 2013.) And what happened to prices for homes in Atlanta? According to CoreLogic, a housing data compiler, home prices in Atlanta increased 12.4% in the 12-month period ended February 2013, compared to a 10.2% increase in the overall U.S. housing market.

Looking forward, I don’t hold a very optimistic view on the U.S. housing market for four very specific reasons: first-time home buyers (desperately needed in any housing recovery) are missing from the action; investors who are buying homes to rent them are pushing prices higher; new homebuilder stocks are down 14% in the past month, according to the Dow Jones U.S. Home Construction Index; and long-term interest rates are moving upward!

Consider Colony American Homes Inc. This company delayed its initial public offering, which would have brought in roughly $230–$260 million, due to what the company says are “market conditions.” This company was formed last year, and it purchased homes in mid- and upscale neighborhoods in the U.S. housing market. On April 30, Colony held 9,931 homes in nine states. (Source: Wall Street Journal, June 4, 2013.)

For institutional investors, at the end of the day, it’s all about the profit; they are buying homes and renting them out all in search of a higher return on their money. But institutional buying of American homes will not sustain a recovery in the U.S. housing market.

We need the average American to be involved in the U.S. housing market because he/she provides liquidity and pushes up consumer spending. Increasing home prices right now don’t mean the U.S. housing market has recovered; actually, it’s far from it when first-time home buyers are missing from the action.

As I wrote earlier this week, something is going on in the bond market. Yields on 30-year U.S. Treasuries are spiking. (See “What the Rising Yield on 30-year U.S. Treasuries Is Telling Us.”) Rising long-term interest rates could be another death-bed for the U.S. housing market. And by the way, those homebuilder stocks that went up last year on speculation, I don’t own any of them.

Michael’s Personal Notes:

The stock market is down 500 points in just over a week…does this mean the Dow Jones Industrial Average has finally topped out?

Corporate earnings are weak; we know that. So far for the second quarter of 2013, more than 80% of the companies in the S&P 500 that have issued their corporate earnings guidance have provided a negative outlook. (Source: FactSet, May 31, 2013.)

Yes, the key stock indices have gotten ahead of themselves. In the first two months of the second quarter, the S&P 500 increased five percent; but as that was happening, earnings estimates for the quarter dropped by 3.4%!

At the end of March, analysts expected the S&P 500 companies to register an increase of 4.4% in their corporate earnings for the second quarter; now that number has dropped to a paltry 1.3%. (Source: FactSet, May 31, 2013.)

In the first quarter of 2013, companies in the key stock indices struggled with revenue growth. Only 46% of the S&P 500 companies recorded revenues above estimates for the first quarter, while the average for the last four quarters was 52%.

But there are further threats to corporate earnings. Demand is weak in the U.S. economy, as the American consumer is still under pressure—he or she is typically working at a job that pays the minimum wage (that’s where most of our jobs growth has been since the Great Recession ended), while the costs of basic necessities continue to rise in an environment where the government says there is no inflation.

I remain skeptical of the rise in the key stock indices, as they aren’t moving in line with the current business conditions in the U.S. economy. I continue to believe the bear market rally, which began in 2009, has done a great job in luring investors back into the stock market. The key stock indices are up significantly and have given investors a false hope that they will climb further.

The S&P 500 has been making lower lows and lower highs since May 22 (as you can see in the chart below), but from what I’ve read from stock advisors, they say to buy on dips—advice I’m not following.

Chart courtesy of www.StockCharts.com

What’s going on with the equity markets right now reminds me of 2007 all over again—that’s when the key stock indices were moving higher, regardless of what was happening with the economy. We are experiencing something similar to that right now, with the stock market and economy having gone in such opposite directions.

Predicting the exact point at which the top will be in for the stock market is difficult, if not impossible, but odds are we are very close.

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 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.

The Association of American Railroads (AAR) is the industry group for North American railroad stocks, and while all trade groups are to be taken with a grain of salt, you can garner insight on the U.S. economy by reading the AAR’s data.

Even if you aren’t interested in railroad stocks, business conditions for railroads are still very relevant. They remain the backbone of North America and the industrial economy.

According to the AAR, U.S. Class I railroad stocks originated a record 97,135 carloads of crude oil in the first quarter of 2013. This represents a gain of 20% from 81,122 carloads in the fourth quarter of 2012 and a substantial increase of 166% from 36,544 carloads originated in the first quarter of 2012.

While the shipment of oil—Bakken oil, in particular—is the source of renewed growth for railroad stocks, the numbers also reveal a flatness that coincides with the rest of the U.S. economy.

The AAR reported that in the first 21 weeks of 2013, U.S. railroad stocks reported volume of 5.8 million total carloads, down 1.8% from the comparable period in 2012. Total U.S. traffic for the first 21 weeks of 2013 was 10.8 million carloads and intermodal units, up 0.8% comparatively.

For the same period, Canadian railroads reported volume of 1.6 million carloads, up 2.3% comparatively, and 1.1 million intermodal units, up 4.7%.

Volume on Mexican railroads came in at 315,377 carloads, up nine percent, with 192,060 intermodal units, down 0.3% from last year.

Railroad stocks have been on a tear lately and are only now taking a little bit of a break. Most railroad companies are right close to their stock market highs.

The AAR, as a trade group, is promoting rail transportation for oil, including Bakken oil, and is citing a number of statistics suggesting that transporting Bakken oil by rail is safer and offers greater reliability over pipelines.

According to the group, total railroad oil spills are less than one percent of total pipeline spills. The group estimates that pipelines spill three-times more oil than railroads.

Weaker shipments of coal, due to the increasing use of natural gas for power plants, has not dented the enthusiasm that institutional investors have to invest in railroad stocks so far. (See “Keeping It Rolling—U.S. Energy Boom Good News for Railroad Stocks.”)

Bill Gates likes railroad stocks. His private investment firm, Cascade Investment, LLC, is now the single largest shareholder in Canadian National Railway Company (NYSE/CNI; TSX/CNR), now owning about 10% of the company. With the addition of the Bill & Melinda Gates Foundation Trust, Gates owns 12% of Canadian National (CN).

Railroad stocks have proven over time to be excellent stock market investments, but they have experienced long periods of nonperformance.

Railroad stocks are very sensitive to general economic conditions and changing preferences among investors. If technology stocks are roaring, who wants to own real railroad stocks?

In my view, there definitely is room in a long-term equity market portfolio for one railroad company.

The railroad sector is an old economy industry that continues to pay.

Yet the main combatants include not only incumbent Netflix, Inc. (NASDAQ/NFLX) but also upstart Amazon.com, Inc. (NASDAQ/AMZN), which in two short years is likely causing some stir at Netflix’s corporate headquarters due to its own video streaming service.

If I was Netflix CEO Reed Hastings, I would be more than worried about the aggressive push of Amazon.com into the video streaming market, based on my stock analysis.

No longer is Amazon.com merely a seller of books and related items, as the company is looking at expanding its business line. My stock analysis suggests this strategy makes a lot of sense, considering that Amazon.com has a significant membership base to draw business from. This is the very real reason why Facebook, Inc. (NASDAQ/FB) needs to monetize its more than one billion users and make money, as my stock analysis indicates. (Read “Facebook Does an About-Face: Set to Move Higher?”)

There is speculation that Amazon.com may have paid as much as $200 million to Viacom Inc. (NASDAQ/VIA) for the rights to show hundreds of shows on its “Amazon Prime Instant Video” streaming service, including those from Nickelodeon, MTV Comedy Central, and others. The move comes after a similar licensing deal between Viacom and Netflix expired. For Amazon.com, it appears to be a great move and hits hard at Netflix. (Source: “Amazon and Viacom reach multiyear licensing deal,” Associated Press, Yahoo! Finance web site, June 4, 2013.)

My stock analysis suggests that Amazon.com has clout, and Netflix better be watching.

With a market cap of $122 billion, Amazon.com is much bigger than Netflix, whose market cap pales in comparison at just less than $13.0 billion.

Sometimes, when a bigger company wants something, it will get it, one way or another, based on my stock analysis.

And while Amazon.com may be behind now, according to my stock analysis, the fact the company has access to its huge membership base is a major advantage over Netflix. According to Morningstar analyst R.J. Hottovy, the Amazon Prime service may have over 10 million members. (Source: Thomas, O., “Amazon Has An Estimated 10 Million Members For Its Surprisingly Profitable Prime Club,” Business Insider, March 11, 2013.) Netflix currently has over 36 million users in 40 countries (source: Netflix, Inc., web site, last accessed June 5, 2013), so it’s ahead of Amazon.com for now.

The comparative cost of the two services is close. Netflix charges $8.00 a month, versus a $79.00 year-long subscription fee for Amazon.com. But for Amazon.com members, there’s the extra benefits, including unlimited free two-day shipping on goods and free access to the “Kindle Owners’ Lending Library” that has over 300,000 e-books that can be borrowed.

But what it will come down to is not only the movie offering, but the special programming that can be viewed only on one or the other’s service, according to my stock analysis.

The chart below shows the recent outperformance of Netflix (shown in the red candlesticks) over Amazon.com (indicated by the solid green line), based on my technical analysis.

Chart courtesy of www.StockCharts.com

It will be a fierce battle online, but given the size of Amazon.com and its membership base, I would probably give the edge to Amazon.com in the long run, based on my stock analysis.

Consider the Purchasing Managers’ Index (PMI) of the U.S. economy tracked by the Institute of Supply Management. Last month it contracted for the first time since November of 2012 and only the second time since July of 2009!

The PMI registered 49.0 in May, compared to 50.7 in April. (Source: Institute of Supply Management, June 3, 2013.) Any reading below 50 suggests the manufacturing sector is experiencing a contraction.

But it’s not just the U.S. economy that’s experiencing a contraction in manufacturing (and affirming the possibility of an economic slowdown). China, the second-biggest hub in the global economy, is seeing the same. In May, the Chinese PMI also showed contraction. The HSBC China Manufacturing PMI registered at 49.2 in May, compared to 50.4 in April. (Source: Markit, June 3, 2013.) Again, any reading below 50 suggests a contraction in the manufacturing sector—which happens to be China’s biggest industry.

Germany, the fourth-biggest producer in the global economy, has been seeing its manufacturing sector contract for some time now. The German PMI registered below 50 in May, the same month the International Monetary Fund slashed the country’s growth outlook in half! The German economy is expected to grow by only 0.3% this year, compared to 0.6% in its previous forecast. (Source: Wall Street Journal, June 3, 2013.)

All of this shouldn’t come as a surprise to Profit Confidential readers. I have been harping on about this issue in these pages for some time now: the global economy is on the brink of an economic slowdown.

Warning: we have a significant amount of information pouring in each day suggesting an economic slowdown in the global economy is pacing faster. Remember, the U.S. economy is very reactive to the global economy, and the direction of the economic trajectory and the stock market are highly dependent on it.

Unfortunately, to fix these softening economies, central banks in the global economy have taken the same approach as the Federal Reserve and the Bank of Japan—lower interest rates and print more money.

Dear reader, the problem in the global economy is that demand is anemic; printing more paper money doesn’t create demand.

Being cautious is the best investment strategy right now.

Michael’s Personal Notes:

As economic conditions in the U.S. and the global economy deteriorate, and as central banks around the world print more money in their misguided attempts to spur growth, more and more analysts are saying that gold bullion’s best days are behind it. Their reasoning: the economy is improving, the Fed will cut back on its monetary stimulus, the worst is behind us, and there’s no more crisis, so there’s no more reason for gold to rise—this is the exact opposite of what I’m saying!

The gold bears fail to realize there are fundamental forces at play behind the gold bullion bull market.

Central banks around the world are looking at gold bullion as an alternative to the currencies they hold in their reserves. It is well documented in these pages how major central banks like the ones from Russia and Turkey continue to buy gold bullion.

Then there is the central bank of China. Its official reserve reached a value of $3.44 trillion in the first quarter of 2013—similar to the size of Germany’s economy. China increased its reserve by $128 billion in the first quarter, making it the biggest increase in reserve since the second quarter of 2011. (Source: Financial Times, April 11, 2013.) My bet is that most of that reserve is in U.S. dollars, which China would desperately like to get rid of.

With that said, China doesn’t have as much gold bullion to back its reserves as countries like the U.S., Germany, and France have. As a matter of fact, the Chinese central bank only holds 1.6% of its reserves in gold bullion, compared to 75.6% for the U.S. and 72.0% for Germany. (Source: World Gold Council, May 2013.)

To bring its total gold bullion holdings to 10% of its reserves, the central bank of China would need to allocate about $344 billion of its reserves to buy gold bullion.

Add strong demand from countries like India to the fact that China needs to increase its gold reserves, and the fundamental demand behind gold bullion is clear. According to the World Gold Council’s estimates, demand for gold bullion in India is expected to jump 150% by the end of June as compared to last year. (Source: Wall Street Journal, June 3, 2013.)

The amount of gold bullion and silver imported in India reached $7.5 billion in April—more than double the amount from a year earlier. The Indian government has increased its import tax from two percent to six percent in a matter of just 1.5 years to curb demand. (Source: Wall Street Journal, May 20, 2013.)

The demand for gold bullion is as strong as ever.

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 home builder, filed for Chapter 11 protection on August 4, 2008.

The gold bears fail to realize there are fundamental forces at play behind the gold bullion bull market.

Central banks around the world are looking at gold bullion as an alternative to the currencies they hold in their reserves. It is well documented in these pages how major central banks like the ones from Russia and Turkey continue to buy gold bullion.

Then there is the central bank of China. Its official reserve reached a value of $3.44 trillion in the first quarter of 2013—similar to the size of Germany’s economy. China increased its reserve by $128 billion in the first quarter, making it the biggest increase in reserve since the second quarter of 2011. (Source: Financial Times, April 11, 2013.) My bet is that most of that reserve is in U.S. dollars, which China would desperately like to get rid of.

With that said, China doesn’t have as much gold bullion to back its reserves as countries like the U.S., Germany, and France have. As a matter of fact, the Chinese central bank only holds 1.6% of its reserves in gold bullion, compared to 75.6% for the U.S. and 72.0% for Germany. (Source: World Gold Council, May 2013.)

To bring its total gold bullion holdings to 10% of its reserves, the central bank of China would need to allocate about $344 billion of its reserves to buy gold bullion.

Add strong demand from countries like India to the fact that China needs to increase its gold reserves, and the fundamental demand behind gold bullion is clear. According to the World Gold Council’s estimates, demand for gold bullion in India is expected to jump 150% by the end of June as compared to last year. (Source: Wall Street Journal, June 3, 2013.)

The amount of gold bullion and silver imported in India reached $7.5 billion in April—more than double the amount from a year earlier. The Indian government has increased its import tax from two percent to six percent in a matter of just 1.5 years to curb demand. (Source: Wall Street Journal, May 20, 2013.)

The demand for gold bullion is as strong as ever.

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 home builder, filed for Chapter 11 protection on August 4, 2008.

But there are very few good books about trading capital markets. Two excellent works regarding capital markets that feature highly successful traders/investors are Market Wizards and The New Market Wizards, both written by Jack D. Schwager. These two books may be older titles, but they are still required reading for any serious trader/investor.

Schwager chose an interview format for his books, asking specific and learned questions to very successful traders that made it big from capital markets.

Interviewees ran the gamut from equity fund managers, to derivatives traders, to individuals who quit their jobs and each became a full-time trader/investor. Schwager’s goal was to help readers get an understanding of what it takes to become a winning trader in capital markets, encompassing stocks, bonds, commodities, and currencies.

In the books, Schwager interviewed Marty Schwartz who worked as a Wall Street equity research analyst and lost money investing in stocks for a good 10 years. He quit his job, and with his savings, he bought a seat on the American Stock Exchange for $92,500. He had $20,000 left and borrowed $50,000 from his in-laws. Trading for himself and moving to a home office, in three years, he was earning no less than seven figures annually.

Schwartz couldn’t make money investing in stocks; rather, he changed his approach to capital markets. He switched to technical analysis and traded S&P contracts.

His most important advice: admit when you’re wrong, learn to take losses early, and don’t increase the size of your bets until you’ve doubled or tripled your capital.

James B. Rogers, Jr. offered the following: everything in global capital markets is just a cycle. A paper loss is very much a real loss. Buy change (after a lot of research). Be flexible and invest in anything. Never follow conventional wisdom. Wait for a good trading opportunity to present itself; do nothing in the absence of such an opportunity. (See “Investor’s Manifesto: Five Motivations for Beating Market Chaos and Risk.”)

Richard Driehaus was in research, but opened an account as a trader/investor in stocks at the brokerage firm he worked for. A person in the office who reconciled his trades saw his picks were pretty good, so she gave Driehaus $104,000 to manage. This was his beginning as a fund manager.

Driehaus said that most people look at stock market action negatively, while not being constructive about the trading. Synthesize all news in capital markets, he said, but don’t follow anyone. Buying high to sell higher is often profitable for a trader. Only through your own research can you develop an investing philosophy that earns. Do what works in the stock market, not what is comfortable, said Driehaus.

Among the traders that Schwager interviewed, I noticed a number of commonalities. Here are 10:

1. Take losses early

2. Hard work and consistent discipline are required to be successful

3. Trade infrequently, but trade with conviction

4. Winning is more important than being right

5. Vary the size of your bets based on conviction and investment risk

6. Study capital markets for the action; everything else is noise

7. Home runs are essential to keeping you in the game over time

8. The equity market is neither efficient nor random

9. Learn from mistakes; it is a big treasure hunt

10. Remove your ego from the game

Market Wizards and The New Market Wizards are quite old now, but the words still resonate. Most of the traders viewed speculating in capital markets as a zero-sum game. At the end of the day, the only thing that matters is the trading action and how you are positioned.

Now, while there’s always some validity to why a stock becomes a short selling target, it’s not always the case; this is where I see contrarian trading opportunities.

Going against the grain does work, but there have been cases where a contrarian strategy has blown up in my face. The key here, like any other situation, is to make sure you have an exit strategy. So while some traders view heavy short selling positions as a negative, I view extreme short selling as a possible trade opportunity to make money by betting against the herd.

An excellent example of this is the case with Tesla Motors, Inc. (NASDAQ/TSLA), which saw 62.9% of its float shorted in mid-April, when the stock was trading at the $46.00 level. In my view, the amount of short selling was extreme and worthy of a look for the aggressive trader. The company subsequently reported some numbers and its outlook—all excellent.

The result was a significant pop in the share price of Tesla from investors buying and short-sellers covering. The stock surged 147% in about six weeks, with the shorts falling to 36.9% of the float as of May 15, according to data on Yahoo! Finance. A call option trade on Tesla would have yielded even greater returns due to the leverage used.

Take a look at the chart of Tesla below, and note the two major opening upside gaps as indicated by the purple circles, based on my technical analysis.

Chart courtesy of www.StockCharts.com

Another short selling squeeze that played out is Internet stock Groupon, Inc. (NASDAQ/GRPN), which rocketed 175% from $2.60 in mid-November to its current level at $7.07 per share. (Check out some other top Internet stocks in “Why There’s No Stopping the Internet Sector.”) The upward surge was driven by both new investors and major short covering. On March 28, prior to the major upward push, there were 41.7 million shares shorted on Groupon or 20.1% of the float. (Source: Yahoo! Finance, last accessed June 4, 2013.) As of May 15, shorts accounted for a mere 6.5% of the float.

Chart courtesy of www.StockCharts.com

While Tesla and Groupon were great short selling squeeze opportunities, there are other potential heavy short selling squeeze candidates that could be set to pop, based on their short positions as of May 15.

Some stocks currently being kicked about by traders include: Vera Bradley, Inc. (NASDAQ/VRA), at 72.5% of float; Uni-Pixel, Inc. (NASDAQ/UNXL), 43.2% of float; Pitney Bowes Inc. (NYSE/PBI), 38.1% of float; First Solar, Inc. (NASDAQ/FSLR), 35.8% of float; and GameStop Corp. (NYSE/GME), at 34.9% of float.

From the first trading day of May to the last trading day of the month, the yield on a 30-year U.S. bond increased more than 17%—soaring from 2.81% to above 3.3%. This move is significant for the bond market, because as the yields on bonds rise, the prices of bonds fall.

Chart courtesy of www.StockCharts.com

What does this mean? Traditionally, rising bond yields indicate inflation ahead, something I have been warning about. But if I had to bet, I would say investors have tired on the low yields of bonds and are moving into higher-risk investments, such as the stock market.

What we already know is that as the yields on the U.S. bonds declined, bond investors moved from the security of U.S. government bonds into higher-yielding bonds—those that are higher-risk and are often considered speculative by credit rating agencies.

We can see the move to higher-risk bonds in the number of new non-government bond issues. In the first four months of this year, $115.1 billion worth of high-yield U.S. corporate bonds were issued. (Source: Securities Industry and Financial Markets Association, May 14, 2013.) In 2012, $329.2 billion worth of high-yield debt was issued in the bond market, and in 2011, this number was $224.1 billion. That adds up to $670 billion in corporate bonds in 28 months!

Taking all this into consideration, as the yield on 30-year U.S. bonds moves higher, the yield on corporate bonds in the bond market will rise further and bond prices will go lower—that means bond investors will take a loss if they sell early! And, of course, they will sell early as few investors actually hold long-term bonds until maturity.

According to Lipper Data, high-yield bond funds in the U.S. witnessed withdrawals of $875 million in the week ended May 31. This was the biggest outflow from these types of funds since February. (Source: Bloomberg, May 31, 2013.)

Bond investors need to practice extreme caution, because the dynamics of the bond market have changed. The most basic indicator of the bond market, the 30-year U.S. Treasury, is showing weakness ahead. If this continues further, it will result in an even steeper sell-off throughout the bond market.

Dear reader, when the yields in the bond market fall, bond investors face severe losses. I wouldn’t rule out a mass exodus from the bond market.

Like every company, big pharmaceutical companies experience their own business cycles, but dividend payments within the group are significant and worthy of attention.

Bristol-Myers Squibb Company (NYSE/BMY) was one of the higher dividend paying stocks within the group.

The company got a major Wall Street upgrade from Citigroup, based on its Phase 3 development program for “Nivolumab,” a new cancer treatment.

The company recently experienced renewed stock market momentum after a period of consolidation. Its dividend yield is approximately three percent now because of the run-up. It was closer to five percent not too long ago.

I’m still a fan of combo pharmaceutical companies for long-term portfolios. By this I mean companies with other business lines, rather than pure-play drug development stocks. I’m referring to companies like Johnson & Johnson (NYSE/JNJ), which has pharmaceuticals, consumer products, medical devices, and diagnostics business lines. There’s also Abbott Laboratories (NYSE/ABT), which sells drugs, eye-care products, nutritional products, and dog food.

This multifaceted business approach that includes the expensive, but also rewarding business of drug development creates a nice bit of diversification as the business cycle changes.

Like virtually everything else in the large-cap space, Abbott has done great on the stock market over the last couple of years. The company only experienced two long periods of flat performance since 1999. Abbott’s stock chart is featured below:

Chart courtesy of www.StockCharts.com

In its latest quarterly report, the company’s earnings from continuing operations improved substantially to $545 million, up from $351 million.

Global revenues grew 3.5% on an operational basis to $5.4 billion. Currency translation knocked this back to 1.8%. The company’s strongest growth was in its nutrition division, followed by diagnostics, and then established pharmaceuticals. (See “Why DuPont’s Earnings Results Are So Typical for This Stock Market.”)

Like Johnson & Johnson, Abbott is now trading at an all-time record-high on the stock market. In terms of valuation, however, Abbott has a price-to-earnings (P/E) ratio of approximately 11.5. Johnson & Johnson’s is around 23.

For many years, I’ve seen countless stock market portfolios hold either of these two companies—sometimes both. With the stock market and these positions at all-time record-highs, it is difficult to make the case that they’re worth accumulating at this particular point in time. But with a major retrenchment in the stock market, these stocks would certainly be worthy of consideration for long-term retirement portfolios.

Both companies backed their previously stated 2013 full-year outlooks.

A big pharmaceutical company that’s diversified into other complementary business lines is the way to go if you’re looking to make an investment in this sector. I’m a big believer in the long-term wealth-creating effect of dividend reinvestment. A company with partial dividend reinvestment is also attractive.

The stock market has shown it likes to stick with its winners. With any more upside, these two pharmaceutical giants—Johnson & Johnson and Abbott Laboratories—should keep ticking higher.

Fast-forward a year, and this May has been blooming for the stock market. The key stock indices recorded excellent gains, with the NASDAQ staging its best month in over a year.

The reality is that in spite of several days of selling in mid-April, the current upward move in the stock market this year really hasn’t faced any hurdles, which is a surprise.

In fact, we have yet to see sustained selling or a down month this year, with the exception of the 0.42% decline posted by the Russell 2000 in April. Small-caps came back with a vengeance in May, advancing nearly five percent.

And there will likely be more highs and records in the stock market to come as long as the Federal Reserve and other global central banks continue offering easy money and driving down interest rates. And if 2012 is any indication, it’s looking like full steam ahead.

In 2012, the stock market staged a strong rally following the May meltdown, reporting gains in each month from June to September.

Now, I’m not totally convinced this pattern will happen again this year, but the investment climate as far as the economy and easy money is better than it was in 2012.

The only thing that concerns me is that I just don’t see the current rate of the stock market advance keeping pace. If this were to happen, the Dow would end up with a 41% gain, while the S&P 500 would have advanced 38%. Honestly, I don’t see this happening, which means we could likely see some hesitancy over the next several months—or at least a stock market correction of some meaningful magnitude.

I would view a stock market correction not as a red flag, but as a buying opportunity to jump in and accumulate additional positions. My belief is that this stock market is heading higher.

The only thing that could derail the bull market is the Fed, especially if it decides to pare down its bond buying, which would force longer-term yields higher.

In addition, I’m concerned about the bubble-like conditions in the Japanese stock market, where I feel stocks are extremely vulnerable to more selling. (Read “Why Nikkei Sell-Off May Foreshadow Things to Come.”)

Since trading at a high on May 22, the benchmark Nikkei index has faltered 10.7% and has breached its 50-day moving average, as shown in the chart below, based on my technical analysis.

Chart courtesy of www.StockCharts.com

What concerns me in Japan is the lack of solid buying following the 7.3% correction on May 23. Of course, Japan’s situation is vastly different from the U.S., since Japanese stocks were up 70% in just six months.

The economic slowdown in the global economy I’m talking about is a worldwide pullback in growth. Take India as the first example. According to India’s Central Statistics Office, the Indian economy is growing at five percent—its slowest pace in a decade! The director general of the Confederation of Indian Industry was quoted late last week as saying, “With no visible pick-up in any key levers of the economy, the situation remains grim.” (Source: Mallet, V., “India records slowest growth in a decade,” Financial Times, May 31, 2013.)

China, the second-biggest economic hub in the global economy, is facing headwinds, as its economy is growing at its slowest pace since 2009. Japan has undergone the largest per-capita quantitative easing program in history (its debt-to-gross domestic product [GDP] is running above 200%), and that country is back in a recession.

The unemployment rate in the eurozone was reported last week at 12.2% for April. It was 12.1% in March. The unemployment rate in Spain stood at 26.8 % and in Portugal, it stood at 17.8%. (Source: Eurostat web site, May 31, 2013.)

And industrial metal prices, which are supposed to be a leading indicator, are all heading downward.

Take a look at the chart below of the Dow Jones-UBS Industrial Metals Index. This index provides an overall picture of the performance of industrial metals.

Chart courtesy of www.StockCharts.com

Since the beginning of the year, this industrial metals index has declined about 14%. And, as it has been well-documented in these pages, copper stockpiles are increasing, up significantly since the beginning of the year.

But large nations facing economic slowdowns and industrial metal prices facing sell-offs aren’t the only indicators flashing warnings for what’s ahead in the global economy. Other key indicators like the Baltic Dry Index are suggesting demand is bleak and depressed in the global economy.

I can’t stress this enough, dear reader: the global economy witnessing an economic slowdown means difficult times ahead for us here in North America—it’s a major global economy now, where what happens in one part of the world has ramifications for other countries worldwide.

The U.S. economy is broken. According to a survey conducted by Pew Research, 24% of Americans said in the past 12 months that they had difficulties “putting food on the table.” In 2007, just before the Great Recession struck the U.S. economy, this number stood at 16%. (Source: Pew Research, May 24, 2013.)

We can’t fight another economic crisis in an environment in which our central bank has run out of arsenal to fight an economic slowdown and the government has already raked in a huge amount of national debt. That is why I believe this coming downturn will be significant and not so easy to recover from.

Michael’s Personal Notes:

As I have written in these pages many times before, economic growth in a country happens when people are finding jobs, real wages are rising, consumers are spending, businesses are expanding and seeing their inventories decline, and the general standard of living is rising.

But all of these events are missing in the U.S. economy.

The jobs growth we have witnessed following the Great Recession has been in low-wage-paying sectors. Despite the politicians telling us we have economic growth, we still have a significant number of Americans unemployed or working part-time because there aren’t any full-time jobs for them. The underemployment rate, which I consider to be a better measure of the jobs market situation, still stands around 14%, and it’s been at that number or higher for years.

In periods of economic growth, businesses spend their money, creating higher-paying jobs as they do. In the current U.S. economy, businesses are still shying away from spending; rather, they hold a pessimistic view on the economic growth potential of the current U.S. economy. Many companies have taken to the process of buying their shares back in order to make their per-share corporate earnings look better.

According to the Bureau of Economic Analysis, personal consumption expenditure, a measure of consumer spending in the U.S., decreased 0.2% in April after a dismal rise of only 0.1% in March. (Source: Bureau of Economic Analysis, May 31, 2013.)

Disposable income (what Americans have left after paying taxes) also declined in April, shedding 0.1% in the month.

Even with all the gains in the key stock indices and politicians saying we have economic growth in the U.S., the wealth of Americans is nowhere close to what it was before the financial crisis and recession hit the U.S. economy. According to the Federal Reserve Bank of St. Louis, adjusted for inflation, Americans have gained back only 45% of the wealth they lost during the Great Recession. (Source: Wall Street Journal, May 30, 2013.)

If this is what economic growth looks like, then I don’t even want to think about how horrible a slowdown in the U.S. economy will appear—which will happen because of what is going on in the global economic conditions.

If the Federal Reserve starts to move away from quantitative easing and its easy monetary policies, the actual economic growth picture for the U.S. economy will deteriorate quickly—and that’s why I believe the Fed can’t pull back on its paper money printing anytime soon.

Where the Market Stands; Where It’s Headed:

We are in a stock market that is severely overbought. The bear market has done an excellent job at convincing investors the stock market is safe again…and this time, the bear had a helping-hand—the policies of the Federal Reserve.

Even I’m surprised at how far this market has risen. But the fundamentals behind a real, sustainable stock market rally are missing. The higher this stock market goes, the further the fall. Then what? Let me guess: the Fed will buy stocks to support the crash?

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.

But all of these events are missing in the U.S. economy.

The jobs growth we have witnessed following the Great Recession has been in low-wage-paying sectors. Despite the politicians telling us we have economic growth, we still have a significant number of Americans unemployed or working part-time because there aren’t any full-time jobs for them. The underemployment rate, which I consider to be a better measure of the jobs market situation, still stands around 14%, and it’s been at that number or higher for years.

In periods of economic growth, businesses spend their money, creating higher-paying jobs as they do. In the current U.S. economy, businesses are still shying away from spending; rather, they hold a pessimistic view on the economic growth potential of the current U.S. economy. Many companies have taken to the process of buying their shares back in order to make their per-share corporate earnings look better.

According to the Bureau of Economic Analysis, personal consumption expenditure, a measure of consumer spending in the U.S., decreased 0.2% in April after a dismal rise of only 0.1% in March. (Source: Bureau of Economic Analysis, May 31, 2013.)

Disposable income (what Americans have left after paying taxes) also declined in April, shedding 0.1% in the month.

Even with all the gains in the key stock indices and politicians saying we have economic growth in the U.S., the wealth of Americans is nowhere close to what it was before the financial crisis and recession hit the U.S. economy. According to the Federal Reserve Bank of St. Louis, adjusted for inflation, Americans have gained back only 45% of the wealth they lost during the Great Recession. (Source: Wall Street Journal, May 30, 2013.)

If this is what economic growth looks like, then I don’t even want to think about how horrible a slowdown in the U.S. economy will appear—which will happen because of what is going on in the global economic conditions.

If the Federal Reserve starts to move away from quantitative easing and its easy monetary policies, the actual economic growth picture for the U.S. economy will deteriorate quickly—and that’s why I believe the Fed can’t pull back on its paper money printing anytime soon.

Where the Market Stands; Where It’s Headed:

We are in a stock market that is severely overbought. The bear market has done an excellent job at convincing investors the stock market is safe again…and this time, the bear had a helping-hand—the policies of the Federal Reserve.

Even I’m surprised at how far this market has risen. But the fundamentals behind a real, sustainable stock market rally are missing. The higher this stock market goes, the further the fall. Then what? Let me guess: the Fed will buy stocks to support the crash?

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.

While examining views and portfolios of many large, buy-side institutions, I’ve been reading what could only be described as unscientific cautious optimism for the U.S. economy.

There is an expectation to further accumulate the equity market’s existing winners based on earnings growth and valuations. The buy-side is paid to play, but I read many views with these intentions.

This is including corporations like Wal-Mart Stores, Inc. (NYSE/WMT), Johnson & Johnson (NYSE/JNJ), PepsiCo, Inc. (NYSE/PEP), The Home Depot, Inc. (NYSE/HD), International Business Machines Corporation (NYSE/IBM), and even Berkshire Hathaway, Inc. (NYSE/BRK-A).

Sticking with the equity market’s existing winners does make sense for institutional buyers for a number of reasons: liquidity, earnings reliability, growing dividends, very strong balance sheets, and window dressing. Big investors don’t want to look like they’ve missed the equity market’s top stocks.

Everybody knows what can go wrong, but what’s most important for investors is how you structure your portfolio to deal with the investment risk.

Because of the equity market’s stunning performance since the beginning of the year, I view investment risk as being way up. I am very reticent about buying stocks right now.

But what is most important is what corporations are saying about their businesses and how the institutional mindset interprets it.

Last week, Costco Wholesale Corporation (NASDAQ/COST) reported another solid quarter of growth in sales and earnings. The company said its fiscal third quarter of 2013 (ended May 12, 2013) produced sales growth of eight percent, reaching $23.6 billion.

Comparable store sales (which black out gasoline and currency changes due to volatility) grew a solid seven percent. (See “Retail Stocks Find Big Success in the Great Outdoors.”)

Earnings rose 18% to $459 million, or $1.04 per diluted share. Membership fees (which are highly profitable) jumped to $531 million from $475 million comparatively.

All macroeconomic factors matter, but it’s still the value attributed to a corporation’s business conditions by institutions that drives equity market prices.

Costco’s earnings results were great. As a low-margin, mature corporation, membership fees are an important contributor to Costco’s earnings.

Like so many other corporations, the company’s cash and short-term investments grew nicely from $5.98 billion in the comparable quarter to $6.51 billion, making it likely that the corporation will offer up another dividend increase this year. April’s sales were up seven percent to $7.98 billion, compared to the same period last year.

This equity market will still reward the performance of growing corporations, and Costco’s latest numbers were certainly impressive.

At this juncture, there is no evidence that the landscape for Chinese stocks will improve soon. The Shanghai Composite Index (SCI) is up a mere 2.12% this year, easily underperforming the S&P 500 and the Dow. Even the Nikkei 225 has blown away the SCI.

Just take a look at the comparison in the chart below of the SCI (as indicated by the red candlesticks) and the S&P 500 (as indicated by the green line). The purple oval on the right side of the chart shows the divergence forming between the SCI and the S&P 500 since around 2008, based on my technical analysis.

Chart courtesy of www.StockCharts.com

In the short- to medium-term of less than one year, the SCI will likely continue to underperform the U.S. key stock indices.

For Chinese stocks to come back, two things must happen:

First, China must make sure the Chinese economy doesn’t falter back into a tailspin. The new government, under President Xi Jinping and Premier Li Keqiang, must work to drive domestic consumption in the country to levels similar to those in the United States and Japan, where consumer spending accounts for about two-thirds of the countries’ gross domestic product (GDP). In China, domestic consumer spending currently only accounts for about 25%, so there’s plenty of work ahead.

To increase local spending, Chinese wages must rise. We are seeing this now, but it must continue in both the cities and the rural areas of China. A wealthier China means less dependence on exports and on what happens in the global economy.

China is estimated to show growth that will still far overshadow that of Japan and many parts of the global economy. According to the Organization for Economic Cooperation and Development (OECD), in its semi-annual Economic Outlook report, the agency reported that China is estimated to expand its economy by 7.8% this year, followed by 8.4% in 2014. (Source: “Global economy advancing but pace of recovery varies, says OECD Economic Outlook,” Organization for Economic Cooperation and Development web site, May 29, 2013.)

China is clearly stalling, as evidenced by key companies in the country. In its first-quarter report, Chinese infrastructure company Joy Global Inc. (NYSE/JOY) stated that “China’s economy has not been able to get traction and continued slowing has reduced the demand for coal. Electricity demand is growing at only half the rate of prior years, reflecting a significant deceleration in the economy.” (Source: Alva, M., “Coal Glut, Weak Demand Hit Mining Company Joy Global,” Investor’s Business Daily, May 30, 2013.)

I don’t think China will tank, but the country will continue to struggle to get back on track; albeit, it’s unlikely the country will ever be the way it used to be.

The key is patience, and there are better investing opportunities elsewhere in the world, including our own backyard. (Read “‘Year of Snake’ Favors U.S. Over Chinese Stocks.”)

The central bank of Japan took to repeated rounds of quantitative easing to spur growth in the Japanese economy. Its main goal: improve exports. By selling more to the global economy, the country thought it could witness economic growth.

But the Japanese economy is experiencing the opposite. In April, the Japanese economy’s trade deficit increased to $8.6 billion. This was the widest gap in April trade since 1979. (Source: Bloomberg, May 21, 2013.) Instead of exporting more, Japan is importing at a record pace!

And retail sales in the Japanese economy declined 0.1% in April, continuing their decline from March, when they declined 0.3%. (Source: RTT News, May 28, 2013.)

Simply put, the Japanese yen has become a victim of quantitative easing—but it hasn’t helped the Japanese economy export more as was initially hoped. Since the beginning of the year, the yen is down 16% compared to other major currencies, as depicted in the chart below.

Chart courtesy of www.StockCharts.com

Just as it is here in the good old U.S., the only economic indicator that seemed to be benefiting from the Japanese money printing was the Japanese stock market. Since the beginning of 2013, the Nikkei 225 index has gone up more than 30%…but now it’s dropping like a rock, as corporate profits have failed to materialize to sustain the rally.

Returning to the U.S. economy, the quantitative easing by the Federal Reserve here could have the same effect that quantitative easing had in the Japanese economy—nothing. The demand from consumers in the U.S. economy is weak. The revised estimates of the gross domestic product (GDP) for the U.S. economy as reported by the Bureau of Economic Analysis (BEA) yesterday edged lower to 2.4% in the first quarter of 2013. (The BEA previously reported an increase of 2.5%.)

According to the BEA, inventories in the private sector U.S. businesses have been increasing, reaching $38.3 billion at the end of the first quarter of 2013, compared to $13.3 billion in the fourth quarter of 2012.

Through quantitative easing, the Federal Reserve has printed a significant amount of new money. But will we face the same music here? Instead of having a lower currency spur exports, will currency devaluation backfire for the U.S. just as it did in Japan?

As I have been writing for months, quantitative easing (money printing) is a short-term fix, which if left running for too long, will cause bigger problems than those it was first intended to resolve!

We’re following in the Japanese economy’s footsteps. Massive money printing there failed to boost the economy and only created another stock market bubble that is now bursting—the U.S. will face the same fate.

Michael’s Personal Notes:

Spain, the fourth-biggest economy in the eurozone, is showing us how troubles in the common-currency eurozone region are far from over.

The gross domestic product (GDP) of Spain contracted another 0.5% in the first quarter of 2013 from the fourth quarter of 2012, when it declined 0.8%. (Source: Bloomberg, May 30, 2013.) The Organization for Economic Cooperation and Development (OECD) just slashed its forecast for the Spanish economy and expects the unemployment rate in this eurozone nation to increase to 28%.

And adding to the worries…

The European Central Bank’s (ECB) assessment of the financial system in the eurozone suggested that due to the sharp economic slowdown in the region and a hike in bad bank loans, the risk of a further banking crisis is brewing. The ECB also commented that the weakest world banks were in the eurozone nations that have high unemployment and the most stressed housing markets. (No kidding!) (Source: New York Times, May 29, 2013.)

But it’s not just the small eurozone countries that are suffering; financially larger nations are experiencing an economic slowdown as well. Germany is begging for growth, and France is in a recession!

And austerity is failing miserably throughout Europe.

Consider Portugal, for example; it is experiencing a severe economic slowdown, and it expects to see its GDP contract in 2013 for the third straight year. This eurozone country has met all the requirements asked by those who bailed the nation out with more than $100 billion in cash. But exports to the country aren’t growing as much, and local demand hasn’t recovered. (Source: Wall Street Journal, May 27, 2013.)

The president of Portugal’s Supreme Court of Justice recently warned that the gap between the poor European nations and the richer ones will continue to widen unless Portugal and the other southern eurozone countries leave the common-currency region.

Note: there are political parties in countries like Portugal and Cyprus that have changed their opinions regarding their eurozone membership. Others in Italy want a referendum, two smaller parties in debt-infested Greece want out of the eurozone, and Germany is witnessing the rise of an anti-euro political party.

I realize I’m one of the few economic commentators who keep going back to these problems in the eurozone. I focus on them often because the eurozone troubles are not only unresolved and far from over, but they are also representing a huge risk to the global economy and, of course, a large risk to the U.S. economy. Many economists and the market in general are underestimating the repercussions of the eurozone mess.

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. 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 the worst state of deflation since the Great Depression.

The gross domestic product (GDP) of Spain contracted another 0.5% in the first quarter of 2013 from the fourth quarter of 2012, when it declined 0.8%. (Source: Bloomberg, May 30, 2013.) The Organization for Economic Cooperation and Development (OECD) just slashed its forecast for the Spanish economy and expects the unemployment rate in this eurozone nation to increase to 28%.

And adding to the worries…

The European Central Bank’s (ECB) assessment of the financial system in the eurozone suggested that due to the sharp economic slowdown in the region and a hike in bad bank loans, the risk of a further banking crisis is brewing. The ECB also commented that the weakest world banks were in the eurozone nations that have high unemployment and the most stressed housing markets. (No kidding!) (Source: New York Times, May 29, 2013.)

But it’s not just the small eurozone countries that are suffering; financially larger nations are experiencing an economic slowdown as well. Germany is begging for growth, and France is in a recession!

And austerity is failing miserably throughout Europe.

Consider Portugal, for example; it is experiencing a severe economic slowdown, and it expects to see its GDP contract in 2013 for the third straight year. This eurozone country has met all the requirements asked by those who bailed the nation out with more than $100 billion in cash. But exports to the country aren’t growing as much, and local demand hasn’t recovered. (Source: Wall Street Journal, May 27, 2013.)

The president of Portugal’s Supreme Court of Justice recently warned that the gap between the poor European nations and the richer ones will continue to widen unless Portugal and the other southern eurozone countries leave the common-currency region.

Note: there are political parties in countries like Portugal and Cyprus that have changed their opinions regarding their eurozone membership. Others in Italy want a referendum, two smaller parties in debt-infested Greece want out of the eurozone, and Germany is witnessing the rise of an anti-euro political party.

I realize I’m one of the few economic commentators who keep going back to these problems in the eurozone. I focus on them often because the eurozone troubles are not only unresolved and far from over, but they are also representing a huge risk to the global economy and, of course, a large risk to the U.S. economy. Many economists and the market in general are underestimating the repercussions of the eurozone mess.

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. 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 the worst state of deflation since the Great Depression.

I never root for losses, but with equities having gone up so much, a correction would be beneficial from a technical perspective.

Action in the stock market and blue chips, specifically, has been spectacular this year. But it’s time for a break.

While history proves it’s not wise to fight the Fed or the ticker tape, the stock market is most definitely a leading indicator.

As a fan of dividend-paying blue chips, utilities and consumer staples are good multiyear investment themes. But being at their cyclical highs, I would not be a buyer right now. These stocks are frothy.

I think it’s probable this year that the U.S. economy will outperform other developed economies. I also see the formation of an equity universe, in which big investors are still buying blue chips.

Corporations do have to perform. But with excellent balance sheets among most blue chips, the stock market can finish the year higher than its current level (save for a shock).

The end of quantitative easing is slowly being priced into the stock market. While more news on the subject from the Fed would result in a sell-off, this is not an unexpected reality.

The one shock that this market is not ready for is a rise in short-term interest rates. This is a possibility, perhaps even by the end of this year, depending on economic news.

Long-term cycles are in a state of fluctuation. (See “Stock Market Fake-Out: Where Is the Retrenchment?”)

I remember Black Monday on October 19, 1987. It was an accident waiting to happen. The stock market crashed, lost a ton of money, then made it back in two years.

There was another financial crisis and recession. Inflation and higher interest rates were part of that picture. Then things took off—again.

Still, it is difficult to be bullish considering where the stock market just came from.

Blue chips are fully priced and the marketplace has placed its bet. Second-quarter earnings season must deliver tangible revenue and earnings growth or investors will bail.

A diminishment or the end to quantitative easing isn’t much of a worry from my perspective. It’s always best to leave the marketplace alone. But the short-term interest rate debate is going to heat up, especially if economic data pick up in the bottom half of the year.

So far, the action in blue chips makes sense. If you were going to be a buyer with all this fragility, investors bought the safest names.

The biggest surprise was that the stock market did not sell off on first-quarter earnings. And the fact that it didn’t increases the likelihood of a major near-term retrenchment.

Data just came out from the Mortgage Bankers Association that showed the rise in the average contract interest rate for 30-year fixed-rate mortgages has risen 12 basis points to 3.90%, representing the highest level since May 2012. For 20-year mortgages with a balance in excess of $417,500, the rate jumped 14 basis points to 4.07%. (Source: Robinson, M., Mortgage “Applications Down 3rd Week as Rates Jump,” Mortgage Bankers Association web site, last accessed May 30, 2013.)

The impact of the higher rates on the housing market is clearly seen in the demand for mortgage applications, which declined for the third straight week. For the refinancing segment of the mortgage market, the demand plummeted 12% to the lowest point since December 2012.

Now I’m not saying the housing market is set for a collapse, but you need to be careful and take some profits off the table, which is always a prudent strategy to undertake. (Read: “Why Greed Is Not Your Friend When It Comes to Investing.”)

Based on my technical analysis, the chart of the S&P Homebuilders Index below shows the current hesitancy to move higher at the upper resistance, as indicated by the top blue line. If you look back to December 2012, there’s clearly a chance that prices can falter back to the lower support level, as indicated by the red oval in the chart below.

Chart courtesy of www.StockCharts.com

The reality is that the move away from the recession and subprime mortgage crisis has been superlative, but I feel some pausing may be due in the housing market.

Just take a look at home prices in the top-20 housing markets nationwide, which surged 10.9% in March, according to the S&P/Case-Shiller Home Price Index. March was the 14th straight up month for prices for the housing market and the highest in six years, so you understand my concern.

Of course, the Fed may be inclined to leave its aggressive stimulus in place due to the high unemployment rate, which continues to be well above the Fed’s target rate of 6.5%—it isn’t expected to fall to this level until 2015 or later.

While the jobs will come, the Fed also knows it must control any bubble-like conditions or risk the threat of another implosion, which is not what you want to see at this time.

This is why the Fed will need to inevitably take its foot off the throttle and ease off on the stimulus. This doesn’t mean the economy and housing market will crash and burn, but the easy money in the stock market will be a thing of the past until the next great bull market.

The reality of the situation is that the key stock indices are treading in shark-infested waters and the risks are piling up daily. I see bearish signals all over, but the theme among investors, even conservative investors, continues to be “keep buying.”

It’s official…

Margin debt—that’s the amount of money borrowed to purchase stocks—on the New York Stock Exchange (NYSE) reached its all-time high in April. Margin debt on the NYSE registered at $384.3 billion as the key stock indices hit new record-highs. (Source: New York Stock Exchange web site, last accessed May 29, 2013.) The highest margin debt ever reached prior to this was in July of 2007, when it stood just above $381.0 billion. At that time, just like today, the key stock indices were near their peaks and “buy now before it’s too late” was the prominent theme of the day

Looking ahead, corporate earnings, which ultimately drive the direction of the key stock indices, don’t look so good. So far, 106 companies in key stock indices like the S&P 500 have provided their corporate earnings outlooks for the second quarter, and more than 80% of them have issued earnings outlooks that are negative! Corporate earnings growth for the second quarter is now projected to be only 1.4%—and the estimate keeps going down! (Source: FactSet, May 28, 2013.)

And this chart doesn’t look good either:

Chart courtesy of www.StockCharts.com

The above chart shows the performance of the S&P 500 utilities stocks through an exchange-traded fund (ETF) called the Utilities Select Sector SPDR (NYSEArca/XLU). Why is this chart important? Utilities stocks are considered safe because the companies in the sector usually have good long-term growth and consistent corporate earnings. But this chart shows how investors are fleeing the safety of utilities stocks—and I think they are running to high-risk stock sectors.

But in spite of all these factors, it wouldn’t surprise me to see the key stock indices go even a little higher because of all the buying momentum. The bear market rally, which began in 2009, has done a masterful job at convincing investors that the stock market is safe again—but it will all end in a collapse. It’s only a matter of when it will happen.

Key stock indices rising on anemic economic growth, poor corporate earnings, and leveraged investors—this is not going to end pleasantly.

Michael’s Personal Notes:

The International Monetary Fund (IMF) has officially lowered its growth expectation for the Chinese economy, the second-biggest engine in the global economy. The IMF expects China to grow 7.75% this year compared to the eight percent it previously projected.

The First Deputy Managing Director of the IMF, David Lipton, said, “while china still has significant policy space and financial capacity to maintain stability even in the face of adverse shocks, the margins of safety are narrowing.” (Source: “IMF Forecasts Lower China Growth, Warns on Debt,” Wall Street Journal, May 29, 2013.) This will be the first year since 2009 that China’s economic growth is in the single digits.

France, a key economy in the eurozone and the fifth-biggest in the global economy, is back in a recession for the third time in five years, as the economic slowdown in the country continues to take its toll. In May, consumer sentiment in the French economy reached lows not seen since July of 2008. (Source: France 24, May 28, 2013.)

As I have written before, there is no way the economic slowdown in the global economy will not end up affecting America. The price action in the stock market doesn’t show this, but in the first quarter of 2013, of the 11 companies on the Dow Jones Industrial Average that reported their revenues in Europe, nine of them posted a decline in sales from that region! (Source: FactSet, May 28, 2013.)

Dear reader, while the U.S. economy still hasn’t recovered from the last economic slowdown, more troubles from outside our domestic control lie ahead.

China and France are just a few of the many examples of what’s actually happening in the global economy. Other nations like Japan are facing severe scrutiny as well.

There are several countries in the eurozone that are in an outright depression. The youth unemployment rate in some eurozone countries is close to 50%. In Cyprus, the government has gone so far as to take money right out of its citizens’ bank accounts if their deposits totaled over 100,000 euros.

While you don’t read or hear as much about it as you did last year, the economic issues in the eurozone are dire—and the ramifications for the global economy are very real. Should Germany’s economy soften further, we could see all of Europe come under economic pressure, the winds of which will surely sail across the Atlantic to the West.

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 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. That devastation started happening in the first quarter of 2008.

The First Deputy Managing Director of the IMF, David Lipton, said, “while china still has significant policy space and financial capacity to maintain stability even in the face of adverse shocks, the margins of safety are narrowing.” (Source: “IMF Forecasts Lower China Growth, Warns on Debt,” Wall Street Journal, May 29, 2013.) This will be the first year since 2009 that China’s economic growth is in the single digits.

France, a key economy in the eurozone and the fifth-biggest in the global economy, is back in a recession for the third time in five years, as the economic slowdown in the country continues to take its toll. In May, consumer sentiment in the French economy reached lows not seen since July of 2008. (Source: France 24, May 28, 2013.)

As I have written before, there is no way the economic slowdown in the global economy will not end up affecting America. The price action in the stock market doesn’t show this, but in the first quarter of 2013, of the 11 companies on the Dow Jones Industrial Average that reported their revenues in Europe, nine of them posted a decline in sales from that region! (Source: FactSet, May 28, 2013.)

Dear reader, while the U.S. economy still hasn’t recovered from the last economic slowdown, more troubles from outside our domestic control lie ahead.

China and France are just a few of the many examples of what’s actually happening in the global economy. Other nations like Japan are facing severe scrutiny as well.

There are several countries in the eurozone that are in an outright depression. The youth unemployment rate in some eurozone countries is close to 50%. In Cyprus, the government has gone so far as to take money right out of its citizens’ bank accounts if their deposits totaled over 100,000 euros.

While you don’t read or hear as much about it as you did last year, the economic issues in the eurozone are dire—and the ramifications for the global economy are very real. Should Germany’s economy soften further, we could see all of Europe come under economic pressure, the winds of which will surely sail across the Atlantic to the West.

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 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. That devastation started happening in the first quarter of 2008.