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Is This the End of the 2009-2011 Bull Market?

Last week, the Dow closed below 12,000 for the first time since March 18, after falling for six straight weeks. That hasn't happened since the week ending Sept. 30, 2002, but that was at the tail-end of a 30-month bear market - a great historic buying opportunity.

Compared to the dismal days of 2002, the recent six-week decline has been small (-6.8%). Last year, the S&P fell much further (15.3%) from April 29 to July 1, but then it rose 33% in 10 months. In this latest sell-off, data from EPFR Global tells us that retail and institutional investors withdrew the most money from U.S. mutual funds of any week since August 2010. But selling stocks then, before the launch of QE2, was also a bad move! So what's next?

Global Growth Should Resume Once Japan Recovers

The global economy is still expanding, but at a slower pace. Investors are selling stocks because they are concerned about the U.S. economy after the Fed suddenly ends its second round of quantitative easing (QE2) this month. It's hard for the market to recover when so many investors used Thursday's rally as an excuse to run for the exits (and perhaps a long weekend in a cooler place) on Friday. This malaise could last another few weeks, until we see positive second-quarter earnings announcements come mid-July.

Fortunately, thanks to a weak U.S. dollar, second-quarter corporate earnings are expected to remain strong. There were a few analyst downgrades last week, but those downgrades were predominantly in the troubled retail sector. When investors finally realize that a weak U.S. dollar helps corporate earnings, due to all the multinational stocks that dominate the S&P 500, the stock market will likely firm up in July.

The Commerce Department announced Thursday that the April trade deficit narrowed by 6.7% as imports from Japan declined by a record 40.8%! In particular, auto and auto part imports from Japan declined sharply. Many economists, like Ed Yardeni, are convinced that the Japanese earthquake and tsunami threw a big monkey wrench into global growth, causing trade to dry up. The good news is that the Japanese Purchasing Managers Index (PMI) surged to 51.3 in May, up from 45.7 in April. Since any PMI over 50 signals growth, Japan has apparently regrouped after the earthquake and tsunami in March.

Although the Japanese PMI is finally rising, similar indexes in China and the United States are dangerously close to falling below 50, which would signal a contraction. Due to the Japanese parts disruption, U.S. durable goods orders fell for the third straight month and vehicle sales stalled. Consumers are also shopping less, since the average household must now spend $183 more per month on food and energy. However, Japan's May recovery suggests that the rest of the world economy could follow Japan's lead fairly soon.

Last week's Federal Reserve Beige Book backed up this analysis. Specifically, the Beige Book discussed how the Japanese earthquake and tsunami caused a serious supply chain disruption for the U.S. economy. This implies that when Japan's supply chain returns to normal, economic growth should return to normal.

Even though Ben Bernanke has expressed some caution, many other Fed governors expect a return to robust growth in the second half. In an interview with The Wall Street Journal , Charles Evans, President of the Chicago Fed, said he expects the economy to grow by 3% to 3.25% in 2011, and 3.5% to 3.75% in 2012. In addition, Dallas Fed President Richard Fisher recently said, "I would like to see 3%-plus growth in the second half (2011) and I think it is achievable." And finally, Philadelphia Fed President Charles Plosser sees 3% to 3.5% growth in the second half, adding that "soft patches are not that uncommon."

Loose Lips About 'Double Dips' Could Sink Obama's Ship

Despite the generally upbeat analysis of many Fed officials, both President Obama and Fed Chairman Bernanke mentioned the phrase "double dip" in their public talks last week - even though they argued that the second dip would NOT happen. What they fear most, I presume, is not a global economic slowdown but the failure of their political fortunes in Washington. Mr. Bernanke is concerned what happens when QE2 ends, while President Obama is concerned about re-election if growth remains slow.

It didn't help that the president lost another key economic adviser last week, Austan Goolsbee. Previous departures included Peter Orszag, Christina Romer and Larry Summers. After failing to explain last Friday's slow job growth, Goolsbee suddenly felt the need to return to academia to "avoid forfeiting his seniority" at the prestigious University of Chicago.

There is no progress on limiting federal spending in Washington. Last week, Fitch Ratings became the third credit rating agency to threaten to downgrade the U.S. government's AAA by early August if the deficit ceiling is not raised. This follows similar warnings by Moody's and Standard & Poor's. Congress wants the debt ceiling to be raised $2.4 trillion to allow the government to operate through November 2012, but the Republican leadership wants this debt increase to be tied to $2.4 trillion in spending cuts.

The problem with making any big spending cuts is that the bulk of the deficit comes from automated spending increases in the major entitlement programs. Social Security, Medicare and Medicaid are rising 3.6%, 3.8% and 5.4% per year, respectively. In the 2012 fiscal year, starting Oct. 1, entitlement programs and the interest on the national debt could consume virtually all of the federal tax revenues!

Complicating matters further, USA Today reported last week that the federal government has added $5.3 trillion in future financial obligations, predominately in Medicare and Social Security, by facing the fact that most Americans are living longer in retirement. This means that the federal government now has $61.6 trillion in underfunded financial obligations, or $534,000 per household. This huge obligation now exceeds the average household debt by more than five-fold, but none of this debt is reflected in the 2011 budget deficit, which only accounts for this year's obligations, not all the unfunded future obligations.

OPEC Fights and China Slows

In this morning's briefing, economist Ed Yardeni says there are three global games of "chicken" going on right now. One is between President Obama and Speaker of the House John Boehner over the debt-ceiling negotiations (see above). Another is between ECB President Jean-Claude Trichet and German Finance Minister Wolfgang Schauble over the bailout of Greece, and a third game of chicken is between the two warring OPEC powers, King Abdullah of Saudi Arabia and the Ayatollah Khamenei of Iran.

On Wednesday, the majority of OPEC nations ignored Saudi Arabia's call to boost crude oil output by 1.5 million barrels per day, led by vocal objections from Iran and its ally, Venezuela. These rebels carried the day, as Algeria, Angola, Libya and Iraq sided with Iran. This caused the Saudi Arabian oil minister, Ali Naimi, to say that this was "one of the worst meetings we have ever had." Only three of OPEC's 12 members sided with Saudi Arabia's promise to boost production, but Saudi Arabia's leaders still sent out signals that they will likely increase their crude oil production, regardless of OPEC. This dissent within OPEC led T. Boone Pickens to predict on CNBC that OPEC may be on the verge of breaking up.

Turning to China, World Bank economists have warned that a real estate bubble is one of China's biggest economic risks now. In the past 18 months, the Chinese government has introduced a number of measures to curtail housing speculation, such as raising the required down payment on second homes to 60%, up from 40%, and raising bank reserve requirements. These policies caused apartment sales to fall 37% in April. Overall, Chinese home prices fell 4.86% in April. Chinese homebuyers are angry, since it now takes the equivalent of 32 years of gross income to buy an average home in Shanghai and 57 years of income to buy a home in Beijing. (That seems like the very definition of a housing bubble to me!)

In addition, Chinese exports "fell" to a 19.4% annual growth rate in May, down from a sizzling 29.9% annual pace in April. At the same time, Chinese imports rose by a strong 28.4% (year-over-year), so it appears that China's domestic consumption remains high, even though its export growth is slowing.

There weren't many U.S. economic indicators released last week, but the most positive news was that the U.S. exported record amounts of industrial supplies, capital goods and petroleum in April. This week, we will see the May data for producer prices and retail sales (Tuesday), consumer prices, capacity utilization and industrial production (Wednesday), housing starts and building permits (Thursday) and the leading economic indicators (LEI) on Friday.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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