There is no doubt the U.S. stock market is being affected by the uncertainty in the eurozone. S&P 500 companies have heavy exposure to the European markets.

While there is plenty of proof of the eurozone’s influence on our stock market, I want to update my readers on the tragedies in Spain.

Despite Greece being the center of attention, I reported on Spain recently as being the biggest problem in the eurozone at the moment. I detailed the fact that Spain is experiencing a real estate crash. As such, most mortgage-backed securities funds are losing significant amounts of money as housing prices collapse.

The collapsing real estate market has placed severe pressure on Spanish banks, which have requested that the Spanish government step in and bail them out.

The problem is that the Spanish government is part of the eurozone and, as such, cannot print money at will to provide the liquidity to the Spanish banks.

The bond market sees what is happening and so has pushed interest rates much higher on Spanish bonds, further hurting the eurozone country.

In a meeting of eurozone officials this week, the prime minister of Spain asked the eurozone for help, because the country cannot continue much longer paying such high interest rates.

The only way the eurozone can help push interest rates down is by buying Spanish bonds. At this stage, it is something that the eurozone is not contemplating, which will leave Spain vulnerable to higher rates.

But this is not the worst part. Spain has what can be referred to as 17 independent states. When I talked about Spain, I mentioned the mortgage-backed securities and the real estate crash.

Officially, Spain’s 17 states had debt of eight billion euros. However, it was just uncovered this week that the 17 states were hiding more debt on their books than the market was aware of.

Instead of eight billion euros of debt, the states have 36 billion euros of debt!

This will cause interest rates in Spain to rise even further, as the debt situation—outside of mortgage-backed securities—now becomes an issue as well.

Forget Greece’s problem; the issue with Spain could come to the forefront. Measured by GDP, Spain is a much bigger economy than Greece in the eurozone and so would require huge amounts of money to help it. Spain’s economy is seven times bigger than Greece’s economy! (See: If You Thought Greece Was in Trouble.)

I wrote in the very first week of this year that 2012 would be a devastating year for the eurozone. Unfortunately, my prediction came true. And unfortunately again, I only see the problems in the eurozone deepening.

Where the Market Stands: Where it’s Headed:

Is it all over? Will the Dow Jones Industrial Average ever see the 13,000 level again?

Since March, I have been writing that the stock market has been putting in a huge top in and around the 13,000 level. In technical analysis terms, the right shoulder of classical head-and-shoulder pattern is almost complete.

While I can’t yet count out the bear market rally in stocks that started in March of 2009, its life cycle is near the end. Get ready for stock market oxygen in the form of the long-forgotten, not-much-talked-about QE3.

What He Said:

“The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling—and no one is talking about deflation but me. Fed governors are still talking about inflation—they’ve got it wrong. There’s no need for me to get into the dangers of deflation, as I’ve written about them (many times) before. Let’s just put it this way: deflation is about the worse economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” Michael Lombardi in PROFIT CONFIDENTIAL, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.

The best gift we’ve gotten from the current stock market correction is lower oil prices. Oil just under $100.00 a barrel accurately reflects global fundamentals; but, around $90.00 a barrel, oil prices are oversold in my view.

Oil prices have come down significantly due to a combination of factors, all occurring about the same time. When you get situations like this (which don’t happen very often), when a number of global fundamentals come together commensurately, there’s always the opportunity for a major price move and, therefore, major profits. Lower oil prices are an absolute gift to the global economy right now. More quantitative easing from the Federal Reserve would boost the stock market more directly, but falling oil prices immediately affect the wallets of all consumers in developing and mature economies.

That’s why I’m keeping a close eye on railroad stocks right now. I love the railroad business and I love it even more when diesel prices are falling. Owning brand-name railroad stocks has proven to be highly profitable over the long term and, as a stock market sector, often ignored by Main Street investors. (See My Favorite Benchmark Stocks That Lead the Stock Market.) Perhaps the industry is just too “old world” for some. Warren Buffett liked the railroad business so much that, in 2009, his investment company purchased Burlington Northern Santa Fe railway outright. It was a great move and his timing could not have been more perfect.

During first-quarter earnings season, many railroad companies noted that they were able to increase their freight prices without affecting demand. In addition, they were able to grow their earnings despite a significant increase in diesel fuel costs, due to higher oil prices. I think this trend is going to continue going into 2013 and lower oil prices will be the icing on the earnings cake. There’s no rush in this stock market—that’s for sure; but if the stock market corrects further, I’d consider railroad stocks for new income-seeking investors.

Right now, fear and uncertainty are taking over investor sentiment in the stock market. Most of the gains since the beginning of the year have eroded significantly and, while corporations aren’t changing their tune, economic news outside of North America is weakening.

I see the stock market correcting further over the very near term with continued falling oil prices, perhaps below $90.00 a barrel. The price correction in gold and silver should also continue as the U.S. dollar outperforms its fundamentals, because of all the sovereign debt turmoil in the eurozone. As I say, there’s no need to be a buyer in this stock market—investment risk remains very high. I still weight most of my outlook towards what corporations say about their businesses. No doubt there will be continued turmoil until second-quarter earning season begins. It can’t come soon enough.

As I’m sure you’ve heard…

Tax increases and government spending cuts in the U.S. are set to take place on January 1, 2013.

Originally, the purpose of the payroll tax cuts was to stimulate the U.S. economy; government spending programs (like extending unemployment benefits) were also aimed at getting the economic recovery going.

The tax cuts and government spending initiatives that were enacted to help the economy “rebound” from the crisis and recession of 2007 add up to roughly $433 billion, or approximately 2.9% of U.S. gross domestic product (GDP) (source: Bloomberg).

If GDP growth is expected to be in the two-percent range in 2013 and we subtract 2.9% from it, then we automatically get a recession number of -0.9% for GDP growth.

As we get closer to the U.S. Presidential election and to the first day of 2013, the press has paid closer attention to the tax cuts and government spending initiatives being reversed, because of the recession implications…so much so that January 1, 2013, is now being referred to as the “fiscal cliff.”

Just this week, the U.S. Congressional Budget Office (CBO) put out a note stating that Congress needs to address the fiscal cliff or the U.S. economy could be in a recession in the first part of 2013.

Of course, the issue will most likely not be addressed until right after the election, giving Congress very little time to act. (It might not matter anyway; a recession-plagued Europe, a slowing Chinese economy, and a slowing U.S. economy might put us in recession before 2013). (See: Economic Growth in the Second Half of 2012 to Deteriorate.)

It’s ironic that the combined end of the payroll tax and government spending incentives are referred to as the fiscal cliff, because of the assumption it will surely send us into a recession. But should we look at this differently? Should we say yes, let’s end the payroll tax cuts; let’s end government spending? If we did let the initiatives lapse, the U.S. would get its first “light version” of austerity measures.

We can look at most of recession-plagued Europe and say that it’s a mess. But Germany at least was attempting to rein in some of the massive government spending and debt that got us all into trouble in the first place.

It can be argued that Germany’s austerity measures went too far and plunged most of the eurozone into a recession. But here in the U.S., we are not even attempting to pay down our massive debt, which stands at over $15.7 trillion today.

Over the past months, in theses pages, I have made the prediction that the U.S. will experience its fifth straight consecutive year of trillion-dollar deficits in 2013.

In the end, I believe most of these tax cuts and government spending programs will remain, adding to the problems of rising massive debt. I have been also predicting that, by the end of this decade, the official U.S. national debt will surpass $20.0 trillion. I think I was too conservative—we will hit the number much sooner than 2020.

Personally, I believe many areas of the U.S. economy never exited the Great Recession of 2008. The U.S. employment numbers mask what’s really going on in this country, because they exclude people who have given up looking for work and those people stuck with part-time jobs who really want full-time jobs.

Rising government debt and expanding money supply; we can’t hold-up the U.S. economy forever with these two principal sources of support. I guess the real question has become, “How long can we go on masking the recession?”

Michael’s Personal Notes:

Like a household selling its personal belongings to pay its debt, some eurozone countries are leasing their historic sites to pay their debts.

I have been writing about the European debt crisis. Besides the unemployment rates being at elevated levels in the eurozone, many southern eurozone countries have such high debt levels that they are literally running out of money.

To pay down some of the debt and to prevent from defaulting on their debts, Greece is thinking of selling its islands.

While Greece hopes to hold on to its national treasures and what made the country what it is today, another southern eurozone country is going the leasing route.

In the eurozone country of Italy, the government of Sardinia is initiating a program to create 30-year leases to interested investors who would like to restore and create exclusive hotels and resorts with the country’s historic lighthouses (source: The Telegraph, May 23, 2012).

There are 15 such picturesque lighthouses nestled in coves overlooking some of Sardinia’s major tourist areas and some of the most beautiful ocean and beaches in the world.

The government does not have the money to restore these sites, and since they are only accessible by boat, they have been left abandoned; the problems of the eurozone taking precedence.

However, one Italian businessman finally convinced the government of Sardinia to lease one lighthouse to him. The businessman pays the government rent, which helps the government pay its debts to the eurozone.

Not only did the businessman restore one lighthouse, but he also converted it into a hotel where tourists feel like they have their own little island resort during their stay.

Since the government needs more money to appease the eurozone, they have thrown open the doors to any foreign investor; the European debt crisis demands more austerity.

This might actually be better for the government and for people in general. Keeping empty lighthouses doesn’t help anyone, while restored ones pay rent and there is further money generated from tourists visiting them and staying on the islands.

The only fear I have is that this talk of Greek islands and now Italy’s lighthouses doesn’t lead to eventual sales. The European debt crisis will hopefully not escalate to the point of countries in the eurozone having to sell their identity to bondholders. That would be a crying shame.

Of course, before they get to that point, one can see these eurozone countries exiting the eurozone instead of conceding to such demands.

Where the Market Stands; Where it’s Headed:

It’s a totally ridiculous situation…

This morning, the yield on the 10-year U.S. Treasury hit a low of 1.77%. As the situation in Europe continues to deteriorate, as investors see growth in China coming down fast, investors are flocking to the “safety” of U.S. Treasuries. This is where it gets confusing.

The U.S. is a stone’s throw away from its own recession. So why would investors flock to U.S. Treasuries for safety? It’s a very simple answer. The U.S. central bank is the only one in the world that openly said, “If the economy gets worse, we will expand the money supply again.” That’s not an exact quote from the Federal Reserve, but rather my ballpark understanding of what they are saying. Obviously, other investors see it the same way, because they are buying 10-year U.S. Treasuries below the inflation rate!

In the eurozone, Germany will not let the European Central Bank (ECB) print money. Hence, the run on European banks and the blatantly difficult eurozone economies.

In the wake of the 10-year U.S. Treasury hitting a new low today, something different is happening. Gold is up $28.00 an ounce as I write. Usually, as the yield on the Treasuries falls, gold falls in price. Maybe investors are catching up to the fact that the only way to pay back these Treasuries is with even more inflationary money printing. (Also see: Paying the U.S. Government to Hold Your Money.)

What He Said:

“As investors, we need to take a serious look at our investment portfolios and ask, ‘How will my investments be affected by an American-grown recession?’ You should take what precautionary steps you can right now to protect yourself from a recession in 2007. Maybe you need to cut your own spending or maybe you need to sell some stocks that will take a beating during a recession. You know what tidying up you need to do. Don’t procrastinate…get to it now. And please remember: Recessions can happen quickly, stock markets don’t go up during recessions, and the longer the boom before the recession, the longer the recession. Just based on my last point, we have plenty to worry about in 2007.” Michael Lombardi in PROFIT CONFIDENTIAL, November 13, 2006. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.

A little stock market bounce-back is a welcome development. We likely won’t see any material new trend develop until second-quarter earnings season begins. Investment risk is still very high, but there is good news out there.

In the continuing story of a strong retail sector, Ralph Lauren Corporation (NYSE/RL) announced excellent financial growth in its fiscal fourth quarter and management also announced a doubling of its quarterly dividend. When I read news like this, it bolsters my view that the U.S. economy is stronger than the marketplace currently thinks. In a consumer-driven economy, what the retail sector reports is very important news.

According to Ralph Lauren, its fiscal fourth-quarter revenues, ended March 31, 2012, grew a solid 14% to $1.6 billion over revenues of $1.4 billion generated in the same quarter last year. The company experienced double-digit sales growth with particular strength at the retail level. Earnings in the latest quarter grew 29% to $94.0 million. For all of fiscal 2012, the company’s revenues grew 21% to $6.9 billion.

The stock market has been awfully kind to Ralph Lauren; the stock has been in a sustained uptrend since 2003. No doubt the doubling of its dividend will attract more institutional ownership. The stock market jumped on the news.

And other companies in the retail sector are experiencing solid sales growth. Macys, Inc. (NYSE/M) and Target Corporation (NYSE/TGT) have been on a stock market tear lately. Companies like Under Armour, Inc. (NYSE/UA), Nike, Inc. (NYSE/NKE), and lululemon athletica inc. (NASDAQ/LULU) have been really strong on the stock market since the beginning of the year.

On balance, I’d have to say that business activity in the retail sector is generally good and that’s a solid vote of confidence for the U.S. economy. Even Harley-Davidson, Inc. (NYSE/HOG) reported a very solid first quarter, saying that motorcycle sales are accelerating. (See Benchmark Stocks Reporting Great Earnings—But the Stock Market Bet on this Already.) In any recession, the first things to drop are non-essential luxury items like “Harleys.” If sales of Harleys are going up with a stronger U.S. dollar, then the world is definitely not falling apart.

I’ll be looking at the retail sector very closely this second-quarter earnings season. A lot of these companies have been stock market leaders for the last couple of years. If corporate visibility from the retail sector is mostly good, then I won’t worry too much about the rest of this year. As soon as management says that retail sector sales are going soft, we have our next recession.