Exactly Where We Are in This
Secular Bear Market

In a secular bear market, which is where I firmly believe we are today, there are three phases:

A phase I bear market (often referred to as the first down-leg) brings stock prices crashing down. From its high of 14,164 in October 2007, the Dow Jones Industrial Average crashed to 6,440 by March 2009—a 55% drop. This phase of the secular bear market is behind us.

A phase II bear market (often referred to as the “rebound,” “bounce” or “sucker’s rally”) started in March of 2009. The Dow Jones Industrial Average has risen 89% since March 9, 2009. The bear market has been doing an excellent job during this current phase of luring investors back into the stock market. Phase II bear markets give investors the false impression that the economy has turned the corner, that stocks are a safe bet again. This phase of the secular bear market is still upon us.

Given that 2012 is a Presidential election year in the U.S., given that the government and the Fed have fought the natural forces of the bear market tooth and nail, the bear market rally, the “bounce” in this secular bear market, has been long.

Phase III of the secular bear market is when stock prices come crashing down again, bringing stock prices down to the point at which the phase I bear market started or lower—in this case, 6,440 on the Dow Jones Industrial Average, about 50% below where the stock market sits today.

Yes, I’m sure many of my readers are sitting there, reading this, and saying, “Michael, this can’t happen. Our economy would crash again.” I also understand that I’m one of the few stock market analysts out there with this opinion. But history is history. What I have explained above, the stark reality of where we are with the stock market, is how a secular bear market works.

The government can take on as much debt as it likes (which is actually a terrible thing for the economy in the long term) and our central bank can increase the money supply as much it wants (another terrible exercise, as inflation and higher interest rates are always the end result of too much money printing). The natural forces of a secular bear market will eventually play themselves out.

Michael’s Personal Notes:

What will happen to the U.S. housing market in 2012?

As we close out 2011, we will have experienced the fifth consecutive year that home prices in the U.S. have declined. According to the popular S&P/Case-Shiller Index,U.S. home prices are down 31% from their mid-2006 peak.

Several reports have been circulated stating that the bottom for home prices is in or will be in sometime in 2012. And there are still those who expect 2012 to be the sixth consecutive year that home prices fall. A recent report from Freddie Mac says that home prices will fall one percent in 2012 and rise in 2013. Other analysts and economists have been more negative saying that home prices will fall up to seven percent in 2012. However, the majority do expect a bottom in 2012 or 2013.

As I have written before, home buyers can get a 30-year fixed mortgage in theU.S.today for 3.91%—the lowest interest rate on a 30-year fixed in 41 years! The problem is that the majority of would-be buyers can’t get qualified, because lending conditions have tightened.

There are several structure issues hindering the U.S. housing market:

A huge inventory of foreclosed homes overhangs the sector. For 2011, foreclosures by lenders of U.S. homes have consistently been in the 200,000 units per month range.

About one in four homes in the U.S. that have a mortgage are worth less than the mortgage.

The attitude toward home-ownership has changed. The rental market is booming in many states. Consumers don’t want to get burned again or, in many cases, they simply don’t have the down payment or creditworthiness to qualify for a mortgage to buy a home.

The tight lending practices of banks have not loosened. And I personally believe there are hundreds of thousands of defaulted home mortgages on the books of the big banks that have yet to enter the foreclosure process.

My prediction is for U.S. home prices to fall in the three percent to five percent range in 2012, with a comparative loss in 2013. But here’s where I differ from most economists on housing: I do not believe thatU.S. home prices will move up this decade.

The biggest creation of money that the U.S. central bank has ever undertaken—we are talking a money supply that has been increased by trillions of dollars—will eventually lead to rapid inflation. That inflation will lead to higher interest rates.

Home prices do not rise when interest rates rise—home prices have an inverse relationship to housing. I sincerely believe that we are near the beginning of a new 30- to-40-year uptrend in interest rates. The U.S. housing market will not recover for years and years. (See also: So They Say the U.S. Housing Market Is Getting Better? Read This.)

Where the Market Stands; Where it’s Headed:

“Inch by inch,” the bear market rally moves towards making 2011 another up year for stocks. As of this morning, the Dow Jones Industrial Average is up 5.3% for 2011. Add in an average dividend of 2.5% and, in spite of the markets’ whipsaw since May 2, stocks have returned a respectable 7.8% this year.

We are in bear market rally in stocks that started in March of 2009. The rally, a giant rebound from a stock market that basically crashed from December 2007 to March 2009, has been prolonged by the efforts of government to increase its debt and by an overly accommodative central bank. (See: Stock Market: What You Can Expect From It in 2012.)

What He Said:

“Over-built, over-speculated, over-financed and overdone. This is the Florida real estate market right now. For those looking to buy for personal use or investment, hold off! The best deals are yet to come. I continue with my prediction that the hard landing in the U.S. housing market, which is now affecting lenders, will have significant negative effects on the U.S. economy.” Michael Lombardi in PROFIT CONFIDENTIAL, April 3, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.