Stock Market: The Forecast No One Is Talking About But Me

Michaelhas an opinion on the stock market, where it’s headed, which you're not reading or hearing anywhere else. This morning, he presents that forecast for the benefit of our new readers and to ensure that all our readers know where he stands on the stock market’s direction.  I have an opinion on the stock market, where it’s headed, which I’m not reading or hearing anywhere else. I’d like to present that forecast this morning for the benefit of my new readers and to ensure that all my readers know where I stand on the stock market’s direction.

Very quickly, a little history of where we have been…

One of the greatest bull markets in history, with a run in excess of 20 years, came to an end when the Dow Jones Industrial Average peaked out at 14,164 in October of 2007.

From there, a vicious bear market took hold, knocking stocks down by 54% by March of 2009, when the Dow Jones hit 6,440. This is what I classify as Phase I of the bear market: the initial takedown.

Since March of 2009, we have been in a bear market rally, which has taken the Dow Jones up 93% as of this morning. We are presently in the 29th month of the bear market rally. These rallies can easily last three years. This is what I classify as Phase II of the bear market: the “luring.”

Phase II of a bear market is the period in which investors are lured back into the stock market under the pretense that all is well again.

Where we are now and where we are headed…

We are waiting for Phase III of the bear market to start…but it could still be some months off.

Phase III of the bear market will take stocks back down again, with stocks possibly testing their previous lows; in this case, 6,440 on the Dow Jones. I call Phase III the final takedown. It’s the point where the great majority of investors have given up on the stock market and the economy…a great buying opportunity for smart money.

You are likely reading this and saying, “Michael, that’s quite the prediction. You are saying that stocks could fall back down 50%?” To that question, I say, yes; that is correct.

So far, Phase I and Phase II of this bear market have been classical text-book case studies. They have gone off with out a hiccup, and I expect Phase III to be a classical final takedown of stock prices.

I want to specify that I see profits still on the table for stock market investors, albeit not the profits we saw in 2009 and 2010. This market will continue to climb the Wall of Worry. The government will get its debt ceiling lifted, the Dow Jones could even pass the 13,000 level, but time is definitely limited for the rally we have been experiencing.

The United States is in a great period of deleveraging. Phase III of the bear market will finally remove the excesses of the economy.

My evidence…

To date, we have seen two phases of Federal Reserve quantitative easing that have done little, if anything, to revive job growth. (For the record, I do see a form of QE3 ahead, possibly disguised under some other Fed maneuver.) Interest rates in the U.S. have remained at record lows for 32 months now and the desired benefits of such low short-term rates have yet to develop.

The U.S. government has thrown trillions of dollars at this economy and the results have been questionable. What our government and central bank are doing is close to a mirror image of what Japan’s authorities did during its Lost Decade. The result for Japan was a country left in severe debt and debased currency. The percentage of national debt compared to GDP in Japan today sits in excess of 200%.

Finally, the action of the price of gold has been worried. Since I started recommending gold as an investment in 2002, it has risen from under $300.00 per ounce to almost $1,600 an ounce today—a gain of 433%—with no severe price correction. The price of gold is telling us that problems lie ahead.

“Michael, what would it take for you to change your mind on the direction of the stock market?” I’d have to see the government stop throwing money at the economy and I would need to see the government rein in spending, moving towards a balanced budget. I would also need to see short-term interest rates rise and the Fed slowly deleverage its balance sheet. I’m totally against any form of QE3.

However, politicians will never take the route I suggest above. It would not be popular with the voters. The easy way is to spend, spend, spend (money we don’t have). But, throughout history, the countries that have survived and actually prospered are the ones that have exercised prudent fiscal management.

What He Said:

“Over the past few weeks, I’ve written about subprime lenders and how their demise will hurt the U.S. housing market, the economy, and the stock market. There’s no escaping the carnage headed our way, because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom the peaked in 2005, have yet to arrive.” Michael Lombardi in PROFIT CONFIDENTIAL, March 22, 2007. At the same time that Michael wrote this, former Fed Chief Alan Greenspan was quoted as saying, “the worse is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”