The Second Recession:
What It Will Feel Like

Last Friday, I presented you with my seven top reasons why we should be worried about the long-term prospects for U.S. economy. Today, I’m going to shorten the time frame and tell you why I expect we will fall back into a recession soon.

When the credit crisis first hit, there was a lot written in the newspapers and on Internet news sites on how we could be looking at a Great Depression Part II. There was also plenty of media comparisons to what was happening in the U.S. and what happened in Japan’s lost decade of the 1990s.

As the U.S. economy improved in 2009 and 2010 (albeit a turnaround for the economy, one can argue that it was superficially supported by the government’s bail-out actions and the Fed’s printing press) and the stock market moved higher, people forgot about the comparisons to the American economy of the 1930s and the Japanese economy of the 1990s.

Humans typically have a short-term mind set. Ask investors today if they remember 6,440 on the Dow Jones Industrial Average in March of 2009 and the majority will say no. Go a little further back and ask if they remember the days of 15% interest rates in the early 1980s or the energy crisis of the 1970s and they will only have slight recollections.

Me, I’m the kind of fellow who believes that history repeats itself.

The big-picture macro-economic problems in the U.S., as I pointed out Friday, are increasing foreign ownership of America, the price action of gold, increasing national debt, a government gone too big, the devaluation of the U.S. dollar, and the pathetic housing market.

In May we learned that the economy is cooling quickly. The employment rate hit 9.1% in May, consumers spent less in April than expected, and manufacturing grew at its slowest pace in 12 months in May.

After the stock market crashed in 1929, the market picked itself up, the economy turned around, and investors thought it was just a “bump” on the American road to prosperity.

For the benefit of my new readers, let’s look at the similarities between today and the Great Depression:

The stock market crashes in 1929. Eighty years later, in 2008, it does the same thing.

The bear market rally that started in October 1934 lasted until August 1937—35 months—and took the Dow Jones Industrial Average from a level of 90 to 185, a gain of 106%.

The bear market rally that started in March 2009 has lasted 27 months so far and has resulted in the Dow Jones gaining 99% at its recent May 2, 2011 high.

History never repeats exactly the same way. If it did, and the current bear market rally were to follow the same path as the bear market rally of 1934 to 1937, we would have eight months left before the next phase of this bear market gets underway. It could happen earlier, it could happen later, depending what else the Fed has up its sleeve.

But when phase III of the bear market rally starts (phase I is when stock prices decline, phase II is when the rally is back, which is where we are now), the after-effects could be much worse than the Great Depression.

Why? Simply, because our government is in much worse shape today than the government of the 1930s. Technically speaking, if our government was a business, it would be bankrupt. As for the Fed, how long can those printing presses run before the value of the U.S. dollar collapses and inflation becomes a huge problem?

The double-dip recession is not far off, my dear friend. This second recession will cut deeper than the first—it will be a doozy. Prepare for it.

Michael’s Personal Notes:

When a great majority of investors are betting something will happen in the market, it usually doesn’t happen. That’s how the stock market works—it gives investors the opposite of what they expect.

Look at Hong Kong right now. Short selling (a process for making money from falling stock prices) is at its highest level since last September. There’s great concern that the economic engine in China is slowing and investors on the Hong Kong market are betting big-time on its fall.

Here’s why I think they are wrong:

Yes, reverse takeovers by Chinese companies have become a problem in North America. And there is concern that China’s real estate market is in a bubble. But we also need to look at what’s happening to Chinese monetary policy.

To cool off the heated housing market and inflation, the Chinese central bank raised interest rates four times since October. To curb borrowing, bank cash reserve limits have risen just as many times since the fall. Unlike our central bank, China has plenty of room to maneuver its monetary policy to help the economy if need be.

No economy grows at 10% per year forever. Hence, there will be opportunity at some point down the road to make money as China’s economy cools. I just don’t think we are at that point yet in China.

Where the Market Stands; Where it’s Headed:

Okay, I must admit I’m getting a little nervous. The Dow Jones Industrial Average has fallen below 12,000 and the market is showing no mercy on the downside.

I want my readers to be aware of the following:

The Dow Jones has been down six weeks in a row. Despite this, the market still trades above its 50-week moving average and above its early March 2011 lows, which is technically still a bullish sign.

The bear market rally has brought the Dow Jones from 6,440 on March 9, 2009, to an intraday high of 12,876 on May 2, 2011. The halfway point between the low and the high is 9,658. Yes, the Dow Jones would have to break below the 9,658 level for the bear market rally to technically be over.

This is the best-publicized downturn for stocks I’ve seen in a while. The great majority of stock advisors have stepped off their bullish pedestals. I even received an e-mail alert from the good old New York Times on Friday telling me that the Dow Jones had fallen below 12,000 for the first time since March.

Sit tight, my dear reader, sit tight. Something tells me we haven’t seen the end of the bear market, at least not quite yet.

What He Said:

“The proof that the party is over in the U.S. housing market could not be clearer to me. The price action of the new-home builder stocks is telling the true story—these stocks are falling in price daily (and the media is not picking it up). Those who will hurt most when the air is finally let out of the housing market balloon will be those buyers who bought in late 2005. In fact, the latecomers to the U.S. housing market may end up looking like the latecomers to the tech-stock rally that ended so abruptly in 1999.” Michael Lombardi in PROFIT CONFIDENTIAL, March 1, 2006. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.