The Next Step for the Stock Market

 interest ratesFor the benefit of my new readers, and as an update for my long-time readers, today I want to talk about exactly where I believe we are in the stock market.

 After a 25-year bull market in stocks, which was fueled by a 25-year decline in interest rates and a period of great financial leveraging that accompanied collapsing interest rates, a Phase I bear market (often referred to as the first down-leg) brought stock prices down sharply.

 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 about 100% since March 9, 2009.

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 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 and that stocks are a safe bet again—exactly where we are today. 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 this 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 thinking this can’t happen. 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 ($5.0 trillion and counting since President Obama took office) and our central bank can increase the money supply as much it wants (an increase of about $2.0 trillion since the credit crisis began). But too much debt and too much money printing always lead to rapid inflation and higher interest rates.

The natural forces of a secular bear market will eventually play themselves out.

Michael’s Personal Notes:

 There is no question in my mind that the Chinese economy will be the next great world economic power. While many still view China as mainly an export economy, the Chinese economy is already beginning to show that it is much more than that.

 I’ve been talking about how the Chinese economy is experiencing real wage inflation and that, in just a few short years, there will be no great cost advantage to manufacturers setting up in China as opposed to other major industrialized nations.

 This means that the Chinese economy can’t rely on its cheap labor as the sole means of attracting investment, because their labor costs will soon be comparable to labor costs of other developed nations. So what are the Chinese doing about this?

 Just this week, China opened its first car assembly plant in the European Union, in Bulgaria. Yes, a Chinese car manufacturer chose Bulgaria as its base from which to sell cars in the European Union, because of its low labor costs, low taxes, and well-educated workforce.

Where have we heard that before! Only a few short years back, it was U.S. and European car manufacturers and companies setting up in China. The tables have turned. The Chinese economy has grown up.

 The plant will be jointly operated by China’s Great Wall Motor Company and Bulgaria’s Litex Motors, just as other multinationals created joint ventures within China. The plant will eventually assemble 50,000 cars per year, and will initially sell in Bulgaria and neighboring Eastern European countries. The plan is to expand into the European Union.

 Within the Chinese economy, all Chinese automakers are expressing their desire to gain long-term strategic positions within Europe and the U.S.

This is just the latest venture into Europe. In 2010, China’s Geely Automobile Holdings bought Volvo from Ford Motor Company (NYSE/F), while the Chinese economy’s largest carmaker, Chery, owns a share of a Fiat plant in Italy.

 When people ask where the next great multinational companies will come from, dear reader, don’t forget about China. The Chinese economy has grown to the point where powerful companies have now emerged and are ready to take on the world.

 These Chinese companies are not just talking about it; they are taking action and making moves across the globe. The long-term picture for Chinese companies looks very bright. They have the money and are investing throughout the world in order to maintain strong earnings growth.

The Chinese economy and the companies within it are going to challenge the multinationals of both the U.S. and Europe. It might be a good idea, dear reader, to look at up-and-coming companies within the Chinese economy, the next great multinationals.

Where the Market Stands; Where It’s Headed:

It’s just a matter of time before the Dow Jones Industrial Average moves decisively above the 13,000 level. Stock advisor bullishness has pulled back a little (which is good for stocks) and economic news sounds encouraging for investors; maybe stocks are “not such a bad place” to park one’s money is the thinking I’m hearing from investors.

As I have been writing, there is no real “economic” reason for the market rally. The economy isn’t getting better. In my opinion, under the surface, the economy is deteriorating. What lie ahead are inflation and higher interest rates. The stock market has been kept alive the past three years by interest rates that are unnaturally low and an unprecedented expansion of the money supply.

The final stage of the bear market rally…that final blow to the upside…is being set up.

What He Said:

“Bonds could now be a buy: Bonds rise in price when interest rates fall, as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates that the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in PROFIT CONFIDENTIAL, July 24, 2006. The yield on 10-year U.S. Treasuries fell from five percent in the summer of 2006 to 2.4% in October, 2011—doubling the price of the bonds Michael recommended.