There’s a debt crisis brewing not only for European countries, but for America. Profit Confidential editors have been critics of the U.S.’s inability to reign-in government spending. Based on the White House’s own figures, the national debt will reach $20 trillion by the end of this decade—about 140% of our current Gross Domestic Product. In our studies of history, countries who have incurred considerable debt, countries that have experienced a consistent national debt to GDP multiple of 120% or more have experienced currency devaluation. The U.S. dollar has already been in a free-fall since 2009 against other major world currencies. We expect the devaluation of the U.S. dollar to continue as the U.S. continues to pile on the debt. You can find regular commentary on the U.S. dollar in Profit Confidential.

The economic news we keep getting continues to be mediocre, but with a slight positive bias. It’s my view that the U.S. economy is on a stronger footing than the stock market has priced right now. Stock market sentiment is being adversely affected by the political and sovereign debt uncertainty in Europe and this investment risk will continue to be with us going into 2013.

Large-cap, dividend paying stocks continue to be the most attractive in this kind of environment; although there’s no need for investors to jump into any new positions. Investment risk is that high, with most mature economies awash in sovereign debt. It’s a pickle for individuals with money to invest. Safe, short-term investments like cash or money market funds don’t pay interest rates that beat inflation. The bond market is at the end of its bull market and commodities don’t generate any income. So, other than real estate, the stock market is just about all there is for an individual investor who wants some income with the potential for capital gains.

Once again, I repeat my view that stock market investors need to be very conservative with their holdings. The U.S. economy could very well experience another recession next year and the Federal Reserve is just about out of tools to inflate the Main Street economy artificially. This is why I’m advocating a strong, risk-averse investment stance for those looking at stocks. Frankly, the global economy could easily go into total turmoil if Greece’s sovereign debt problems cascade into Spain and Italy. And currency turmoil is the absolute worst kind of crisis you can have. Everything gets distorted when there’s currency instability. Just look at the spot price of gold—gold and silver prices should be higher, but they’re not, because of a stronger U.S. dollar due to problems in the eurozone. (See Just to Interject—the Debt Bomb Is Still Ticking.)

The single greatest risk to your stock market investments is the sovereign debt crisis in Europe. It’s unfortunate that many Western countries just can’t seem to manage their books properly; but, at the end of the day, who is going to vote for more taxes and less services? Just like the subprime mortgage meltdown, the sovereign debt crisis in Europe is likely to cause some serious havoc with your stock market portfolio over the next several years. That’s why, if you’re long the stock market, you’ve got to be conservative with the vast majority of your holdings.

The real problem with the sovereign debt crisis in Europe is that the top European banks (I’m not referring to central banks) own most of the debt. This means that the entire European banking sector is at risk of collapse. We almost lost Wall Street after the subprime mortgage crisis (some may view that as not being a bad thing) and now we’re at risk of losing European capital markets due to sovereign debt.

As an individual investor in this kind of environment, I’d keep my investments at home and conservative. The risks to the stock market outweigh the potential returns and that’s why blue-chip, dividend paying stocks are the only game in town as far as I’m concerned. The U.S. economy is in a slow recovery, but it’s not unrealistic to expect the sovereign debt crisis in Europe to knock the whole thing underwater.

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.

Companies in the U.S., China, Japan, the U.K., and the eurozone will need a staggering $30.0 trillion in new money to refinance corporate debt within the next five years (source: Standard and Poor’s Rating Services).

Because of all the problems in the world that could prevent corporate debt from being refinanced, S&P believes a perfect credit storm could be brewing. I wholeheartedly agree with them.

I believe the eurozone mess coupled with the global economic slowdown that will eventually lead to weaker corporate profits is going to severely hamper the refinancing efforts of trillions of dollars in corporate debt.

The possible breakup of the eurozone and the continued recession in the eurozone could make the refinancing of corporate debt in those countries very difficult. The eurozone banks and the countries themselves already have finances that are very strained.

Just yesterday, we learned the European Central Bank stopped lending to some large Greek banks for the first time.

The U.K. faces similar types of issues, although not as severe as the eurozone. The U.K. is mired in recession, but does possess its own central bank that can print money to help the banking system and so the corporate debt market. Print, print, print!

China is in the enviable position of sitting on plenty of foreign reserves (U.S. dollars). If China sees its corporate debt market needs money, China can dump some of these reserves to help its banks and so its corporations.

On the other hand, Japan has massive debt problems. It will certainly print money should its corporate debt market require it.

The situation in the U.S. is very different.

U.S. non-financial corporations are in good shape, because they are holding so much money on their balance sheets. I would argue that corporations are holding money on their balance sheets because they are scared of another financial crisis like 2008.

U.S. companies don’t want to be cut out of the corporate debt market like they were in 2008, so they are sitting on a record amount of cash.

S&P notes that the biggest risks to the multi-trillion-dollar corporate debt market—an opinion I agree with—are the eurozone crisis, the slowing U.S. economy, the slowdown in China, and the continued unrest in the Middle East, which could send oil prices skyrocketing.

The amount of corporate debt that needs to be refinanced in the next five years is staggering. In our history, we never had so much corporate debt coming up for maturity at one time.

And because there are so many possible problems in the world, I wouldn’t be surprised to see the corporate debt market experience severe strain.

If this is the case, dear reader, it will further exacerbate the economic slowdown, placing us on the path to recession. Corporations create jobs and impact growth. If they can’t finance their corporate debt, the repercussions will be severe.

Michael’s Personal Notes:

How is America faring?

To find the answer, in the past month, I have visited New Jersey, New York, Boston, Palm Beach, and Miami.

Of these five cities (surprise), New York is doing the best. Almost looks like the credit crisis never happened here. Restaurants are full. A new condo building popping up at 432 Park Avenue is asking $6,000 per square foot and getting it. The housing market is hot.

In New Jersey and Boston, the housing market has improved, but it’s far from booming. People are simply happy to have jobs. The amount of money people make at the executive level (I find) is not what it used to be before the credit crisis hit. Students that are graduating with degrees are having a very difficult time finding jobs; hence they are taking transition service-oriented jobs.

Palm Beach, one of the wealthiest enclaves in America, has yet to recover from the credit crisis and from Bernie Madoff. In respect to this housing market, many multi-million-dollar estates are on the market, waiting for that sports figure, well-known entertainer or an Internet billionaire to come along.

In Miami, unemployment is a big problem. The housing market is improving, but only marginally. What’s really happened is that many foreclosures in the housing market have been absorbed. Getting financing to buy a home is difficult. Most people I talk to are still underwater on their homes (owe more than they are worth), but do not want to leave. In reality, I find it a terrible, terrible housing market.

My impression is that people in south Florida are just scraping by. Tourism is keeping Florida going. Take tourism away, and goodbye Florida.

From my various visits, my present impression is that America will not able to sustain another setback like the credit crisis of 2008. There is a growing disparity between the rich and poor with the latter living paycheck to paycheck. The housing market across the country is still in pain, with prices down about 30% since the crisis hit.

Retirees are taking part-time jobs to supplement their income, putting pressure on the strained job market.

I do not see the picture ending well. Years of zero-interest-rate policies and money printing represent attempts to help the economic situation and housing market in the immediate term, but they provide substantial long-term downside risk…as we will soon find out.

Where the Market Stands; Where it’s Headed:

Last fall, I circulated a report that stated the stock market would start to crash in the U.S. on or about April 13, 2012. I was exactly two week early. From the end of April to yesterday, the Dow Jones Industrial Average has collapsed 740 points, or about six percent.

But we should not be afraid. Yesterday, we got news that several members of the Federal Open Market Committee (the Federal Reserve) said that more monetary easing may be required. As I have been predicting for months, as soon as the stock market started to pull back, QE3 would be on the table again.

What a concept. Stock market and economy start to go down; we just print more money to get them both moving again. How long can this process go on for? How long can the Fed fight the natural forces of a secular bull market?

The bear market rally in stocks that started in March of 2009 is getting close to the end of its cycle. I have been warning my readers that the limited upside for the market may not be worth the risk.

What He Said:

“I see the coming recession being deep and difficult because U.S. consumers do not have the savings to spend their way out of the recession. The same thing happened in Japan. The Japan example proved that, when consumer confidence is shattered, even zero percent interest won’t spur consumer spending. The same thing could happen here.” Michael Lombardi in PROFIT CONFIDENTIAL, August 23, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.

Gold and oil prices are having a really difficult time right now and I suspect that the falling price trend will continue for another month or so. The spot price of gold is going down because that commodity was due for a correction and because of strength in the U.S. dollar, which is trading up on worries about the eurozone. Oil prices are going down because of a massive of glut of oil in storage in the U.S. market and due to reduced expectations for global economic growth. It is the age of austerity and, frankly, I think it’s fair to expect a lot of change over the next 18 months, and by change I mean politically, economically and socially.

So far during the recent price correction, the stock market is holding up well. If the S&P 500 Index broke 1,300, I’d be more concerned, but because the market isn’t overpriced, institutional investors will continue to buy dividend yield when the market retreats. As for gold and oil prices; being commodities, they could experience significant price swings for the rest of this year, even as part of a long-term uptrend.

It’s going to be very difficult speculating on the long side in gold and oil stocks over the next several months. Oddly, it seems like the eurozone is calling the shots in U.S. capital markets. At the very least, the sovereign debt crisis is responsible for domestic investor sentiment.

I’m waiting for a bottom in spot gold; when it happens, I believe speculators should jump all over gold-related investments. The only caveat is the risks associated with the euro currency. Any breakup in the eurozone could have a cascading effect on currencies and the resulting “flight to quality” would skew the U.S. dollar above its fundamentals. As gold and oil prices tend to trade inversely to the U.S. dollar, spot gold could be down for a long time, because of the sovereign debt crisis and the resulting currency chaos.

So, it goes without saying that investment risk for investors remains very high at this time. All assets, even real estate values, are vulnerable with currency instability. I don’t know how things will play out in Europe, but the fact of the matter is, Greece never should have been admitted to the euro currency in the first place. In the end, a massive upheaval in the eurozone is likely over the next couple of years and investors need to protect themselves.

Near-term, gold and oil prices should experience more downside, as speculators pile into the trend. I see gold as a very important asset to own for the rest of this decade, but the price of gold will be skewed by the U.S. dollar trading as the only reserve currency. As for oil prices, I figure we’ll see price consolidation around $90.00 a barrel, which will be a boost for consumers and the industrial economy. (See The Winning Stock That’s a Positive Sign for the Economy.) Oil prices are the pulse of capital markets in terms of sentiment and expectations for economic growth. Right now, oil prices are saying things are slowing down.

Unless we get a major shock like war or something related to the sovereign debt crisis in Europe, I don’t think the stock market is going to experience a lot of further downside. Stock prices might drift and then trade range-bound for a couple more months, but stock market valuations are fair and this provides a lot of cushion.

I do think there is more downside potential in gold, silver and oil prices and it’s not just related to slower growth in the global economy. A lot of the price weakness in these commodities is related to strength in the U.S. dollar, which experiences renewed enthusiasm every time there’s an uncertain development in the eurozone.

There remains, in my view, an underlying strength to the stock market at this time. Institutional investors want to be buyers in this market; they only need a reason to do so. I fully expect that large-cap companies that pay dividends will continue to be the market leaders going into 2013, because, in a slow growth environment, dividends income is crucial. I think it’s fair to conclude that expectations for capital gains are fairly low among all stock market investors, so dividends become the only way to beat the inflation rate.

Because we’re now in the lull between earnings seasons, increased dividends announcements are reduced. I think we’ll get another round, however, during second-quarter earnings season, largely because companies can and want to keep shareholders happy. The cash hoard among most large-cap companies remains substantial.

When share prices go down, yields for dividends go up of course. Most of the stock market’s leaders haven’t actually pulled back in price to a very large degree and this contributes to my view that there is solid underlying strength in this stock market. (See Stock Market Correction’s Here—Put Dividend Paying Stocks on Your Radar Screen.) And the fact that stocks are fairly valued suggests to me that further downside will be modest.

Practically, the only thing that equity investors can really count on in this market is dividends income. Things could blow up in Europe, China’s economy could slow even further, or there could be another war in the Middle East. In any scenario I consider, I just don’t see GDP growth accelerating very much. This is why I’m so pro-dividends. Dividends income is the best bet for new investible money in the age of austerity. Everything else, like gold or oil stocks, you have to get timing right in order to make money. With large-cap dividend paying stocks, all you need is the patience.