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THE STOCK MARKET DOCTOR MAKES A SHORT PROGNOSIS

Unfortunately, our doctor is not Doctor Feel Good…at least not in the short run.

The prognosis is not good for the stock markets in the U.S. and Europe. Sure, they can rally, but don't count on any long bull runs. Any stock market runs we get in coming months are more likely to be bear runs, and those are seldom fun.

In our memo for November 26, we predicted four types of events to look for which would take place to ultimately end the current world liquidity crisis.

Prediction 1: New capital investments by sovereign wealth funds and wealthy companies into banks and other financial institutions with problems. This has begun happening and more investments are announced everyday.

Prediction 2: World central banks are going to provide increasing liquidity...this is happening with a vengeance. It seems that every day interest rates are being lowered somewhere, and everyday more liquidity is being provided to the markets by central banks. The latest are large coordinated loans by central banks to keep liquidity in the system. Instead of lending only on conservative government bonds, as had long been the policy, central banks are willing to take other forms of collateral, even junk mortgage paper. In spite of this, the crisis is not curing itself and illiquidity still pervades the world mortgage markets.

Central bank lending against low quality assets like mortgage paper is just a step away from prediction number three.

Prediction 3: An organization will be funded in the U.S. and/or Europe to buy bad mortgages and to make a market in them to provide a market price for illiquid mortgages.

Prediction 4: The U.S. and foreign governments will actually buy low the quality debt. This may happen sooner rather than later. Trial balloons are being floated in Washington D.C. in the last couple of days to renew the Home Owners Loan Corp. This organization was started in 1933 at the depths of the great depression, to buy mortgages from banks at a discount and refinance them on easier terms. It was closed down in 1951 once the depression and the mortgage crisis of the 1930's was long over.

Already in just three weeks, predictions one and two have happened, and will likely continue. Predictions three and four will have to happen soon if the U.S. wants to avert long-term real estate problems like those experienced during the 1930's.

THE CRISIS IS LEADING TO A RECESSION IN THE U.S., AND MAYBE IN EUROPE

This is temporary bad news for all markets. Long term, it is good news.

Historically, when people begin to realize that a recession is probably going to develop a bear market decline sets in. This may happen in the next few weeks. The process of this market decline and recovery will have several steps.

Step 1 is a "slowing down" in world investing psychology. Most all markets see a decline in their P/E ratios and even if corporate earnings continue to grow the stock markets decline in value.

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