The Stock Market: Where it Has Been, Where it Is Headed

An expanded summary of what Michael has been saying about the stock market and where he believes it is headed.For the benefit of the thousands of new readers who have been flocking to this financial e-letter over the past few weeks, the following is an expanded summary of what I have been saying about the stock market and where I believe it is headed.

I started ringing the bell on the housing bubble early. In these very pages on April 27, 2004, I wrote, “We will wish Greenspan never brought interest rates down so low as to entice so many consumers to have such big mortgages.”

On July 21, 2005, I wrote, “The U.S. reduced interest rates in 2004 to their lowest level in 46 years…what did Americans do with their access to easy money? They borrowed and borrowed some more, investing the borrowed money into real estate. Looking ahead, the Fed’s actions (of reducing interest rates so low as to entice consumers to borrow more than they can afford) will one day be regarded as one of the most costly errors committed by it or any other banking system in the last 75 years.”

The rest is history. The year 2005 was the peak of the housing bubble. Air started coming out of the bubble in 2006 and continues to deflate today. As I wrote in PROFIT CONFIDENTIAL on June 6, 2005, “Those investors who believe a dark day will never come for the U.S. property market are just fooling themselves.”

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Why am I talking about the real estate market and what does it have to do with the stock market? The real estate bust basically took financial institutions down with it. This caused a panic and mass exodus out of stocks in 2008 and early 2009.

On August 23, 2006, I started warning about a coming recession—two years before it was actually recognized in GDP numbers. I wrote back then, “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.”

In the summer of 2007 I started comparing the recession headed our way to the Great Depression: “Anyway you look at it, the U.S. housing market is in for a real beating. In the late 1920s, the real estate market crashed first, the stock market second and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Indeed, the stock market crashed in the first quarter of 2009, two years after the real estate market crashed.

Turning to the stock market, on November 29, 2007, I really started yelling that stocks are in trouble: “The Dow Jones Industrial Average, the S&P 500 and the other major stock market indices finished yesterday with the best two-day showing since 2002. I’m looking at the market rally of the past two days as a classic stock market bear trap. As the economy gets closer to contraction, 2008 will likely be a most challenging economic year for Americans.”

In early 2008, I turned outright bearish on stocks and begged my readers to get out of them: “In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: Borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” (January 10, 2008.) The year 2008 ended up being one of the worst years for the stock market since the 1930s.

Finally, I wrote the obituary on October 6, 2008: “A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” From October 6, 2008, to November 27, 2008, the Dow Jones Industrial Average experienced its biggest two-month losses in history.

In March of 2009, the Dow Jones Industrial Average fell to 6,440, a 12-year low and, in the depth of the crisis, when Wall Street was warning Washington that the financial system would come to a halt unless the government started bailing out financial institutions and larger corporations, I turned firmly bullish on stocks. We “jumped in with both feet,” to quote an adage.

In 2009, the various financial advisories published by Lombardi picked 35 stocks that more than doubled in price. In 2010, which was a more difficult year to make money in the stock market, we picked another 21 stocks that went up more than 100%. In total, 56 stocks we picked in 2009 and 2010 doubled in price.

If you have been reading PROFIT CONFIDENTIAL over the past two years, in my daily “Where the Market Stands; Where it’s Headed” section, you have been reading that I believe we are in a bear market rally, which will bring stock prices higher. In late 2010, early 2011, I changed that prediction to basically, “I believe stocks will continue to rise in the immediate term, but I’m turning bearish for the short to long term.”

Immediate term is now. Short term is three to six months forward. As a stock market analyst and economist, market sentiment and monetary policy are of utmost importance to my analysis. With investors turning more and more bullish on the stock market and long-term interest rates rising, I believe the bear market rally that started on March 9, 2009, has limited life left. The easy money in the market has been made.

I believe that stocks will continue to rise in the immediate term for two simple reasons: stocks love to ride the “wall of worry” higher; and too many stock market advisors are calling for a stock market correction. Stocks never do what is expected of them.

Longer-term, we have severe structural problems in America. We are slowly losing our status as the world economic power to China. Our currency could one day lose its status as the official world reserve currency. Interest rates, after a 30-year down cycle, have entered a 30-year up cycle. Inflation could become a real issue. Hence, 2011 could end up being a very challenging year for stocks. My old saying, “Enjoy the stock rally while it lasts, because it won’t” has never been more relevant.