I know, there are dozens of people predicting one, and some for years (a couple who have been spectacularly wrong since 2003!)

For background, I went to 100% Munis in 1999. Stayed there until 2003, when I switched to a diversified portfolio retaining some Munis but also containing a handful of ETFs and some specific stock picks - I am retired, so current income is inherently a part of my strategy, and munis have provided an advantage - near T-bill yields and safety, yet no federal tax (and living in a state-income-tax-free state, this works on that account as well.) Muni interest is also (if you choose carefully) AMT-exempt, which is a bigger and bigger deal every year.

Anyway, here's the case for a coming Bear Market, as I see it, and why I am increasingly defensive in my portfolio.

• Housing. Housing turndowns have led all modern recessions. They are an excellent leading indicator. This particular housing slowdown has been both more pronounced and is likely to continue far longer than the previous ones. In fact, it is the first time we've actually got a prediction on the table for price declines - something that has not happened since the Depression. If you think the housing bear is almost over, in my opinion you're simply delusional. It has, in fact, only just begun.
• The yield curve. It is inverted and has been for months. This typically leads a recession by about two or three quarters. Guess what - time's up!
• Consumer debt. It is at all-time highs. Debt is not just a number - it must be serviced (in the form of, at least, interest payments), which eats into discretionary income. While interest rates are at low levels in terms of historical norms, this is only true when one considers secured debt (e.g. mortgages); unsecured debt is at some of the highest interest rates ever. This is largely due to the dropping of usury laws across the country, which prohibited arbitrarily high interest charges. As a consequence debt that shifts to unsecured forms of credit, such as credit cards, is typically priced at rates two to three times that of secured debt. Credit card debt is typically at rates of from 13-20% with default rates being even higher.
• Consumer debt is increasing shifting to unsecured credit, largely because the "Home Equity" ATM is now, for most people, closed. In April alone there was a nine point two percent increase in unsecured debt. As such, real interest rates paid by real people are rising rapidly even though the Fed Funds rate remains low.
• Employment is not rising. The raw data from the BLS this last month says there were one quarter of a million fewer jobs in April than in March.
• Hours worked are falling and so are inventories. Businesses are increasingly pessimistic. Businesses do not build inventories if they're concerned about being able to sell their products. Capacity utilization has plenty of room - if there was faith in an economic rebound, you'd see inventories being built in preparation for it.
• Same store sales are in the ditch - the worst showing since records started being kept in the 1970s was turned in for April.
• Real inflation numbers are not low. The "Core" CPI is a farce. Do you know anyone who doesn't eat or use energy? Me neither. And food is a big deal - it is far more of the average family's budget than energy. Food has been rising in cost at 10% or so annually for the last two years and is only going to get worse; not only our weak dollar but the Ethanol craze insures this. Oh, and let's not forget the potential for a big corn crop bust this year - flooding in the corn belt now means late planting which threatens yields, while ethanol gobbles up more and more of supply. Corn and other feed prices have doubled in the last year - want to bet this won't hit the price of meat? Never mind that corn is in a huge percentage of things in your grocery store, from soda to pancake syrup. (Look at your labels - "high fructose corn syrup" - there 'ya go!) You only need look at the price of a 12 pack of Coke at WalMart over the last year to see food inflation in action - you could regularly get them at 2 for $5 a year ago, now they're pushing $4 each. Eggs - $88 cents a dozen for Grade A Large last summer. Well north of a buck now. Again, this crimps discretionary income, and thus consumer spending. Evidence? How many "eat out" places reported disappointing numbers this quarter? Far more than reported good results! To add to this anecdotally, a local place I frequent just raised their "happy hour" hot wing price by 26% - the reason cited was a doubling in chicken feed prices.

Now let's add a few more facts to the mix:

• "Funny" financial reporting. The S&P posted the weakest profit growth percentages in three years. However, the real numbers are far worse! For the first time in memory companies have reported "FX" (that is, currency exchange) advantages as actual earnings, even though such exchange swaps are one time events and unlikely to be repeated. Historically companies have adjusted these FX "advantages" (or disadvantages) out and not reported them. Not this time! Take them back out and about 10% of the S&P's "earnings growth" disappears. Remove foreign sales growth and essentially all of it disappears. As a group the S&Ps sales and earnings growth in the US was, for the first quarter, horrible.
• P/E/G ratios are historically high. The S&P is selling for about 15 times earnings, yet earnings growth was right near 10% in the first quarter. That suggests that the S&P is about 30% overvalued - unless earnings growth is due to go back into the 15-20% range in the next quarter. Nobody expects that to happen in either the second or third quarters!
• Credit yield spreads. In short, they're extremely tight. This means that the credit markets believe there is little or no risk in corporate debt. We know, of course, that nothing could be further from the truth. Yet the veritable flood of bond issues has led to lots of liquidity and with huge supply-side overhang, spreads have fallen dramatically. This presages a corrective event in the credit markets, which has always been the kick-off event for a severe correction in Equities.
• Firms are buying back stock not with free cash flow but with debt issues. As a consequence of the tight spreads, this is a "no-brainer" CEO exercise. But is it smart? Consider this - if a company buys stock back what its telling you is that there is nowhere they can deploy that same capital at those same favorable rates which will return more to you as a shareholder through growing the business! This is a bearish indicator, not a bullish one over any significant amount of time. (It does, however, in the short term boost stock prices.)
• Investable capital is contracting. If we ignore all this "excess liquidity" from unreasonably-cheap bond issues what's left in terms of the stock market is "investable capital." This is real money earned by real people; remember, all funds are really earned by individuals, not corporations, as it is people who create things, not companies. When all the game-playing is stripped out what's happening here is profound - the closing of the housing bubble, which is almost certain to persist through 2010, presages a far greater problem in that the Boomers will begin to retire at that point. When they do, they will start drawing down those 401ks and IRAs, withdrawing capital from the markets! This shift has already begun but will accelerate significantly in the years ahead.
• Manufacturing and other high-paying jobs are increasingly disappearing from the United States. Some people have called what's replacing them "McJobs", and they're not far from the truth. There was a major bust in high-paying jobs after the 2000 tech wreck and salaries in many technical fields were cut in half - or worse. Increasingly companies are turning to hiring foreign workers - legally or otherwise - to avoid paying higher wages to Americans. This is great for corporate profits but bites if you're one of the workers who has had their job eliminated.
• Gasoline prices are over $3 a gallon nationally and are likely to exceed $4 this summer. One good hurricane aims at the Gulf and they could go over $5! Why? We haven't built a refinery in 30 years! We have nobody but ourselves to blame for high energy prices, but we also can't fix it in the near term - it requires 5 years or more to bring new supply sources online in the oil and gas markets. We're just going to have to suck it up and deal with it for now.
• Oh, and let's not forget - the consumer is 70% of the US Economy.

So what is the trigger event and when does it happen?

Now you're asking me to use a crystal ball.

Back in early April I said I thought we had topped in February. I still believe that. By "top" I mean a sustainable, rational market top. What we're doing now is neither sustainable or rational. The Dow is in what amounts to a Parabolic rise the last two months on weak data and even weaker forecasts for the future.

In short, the market is running on pure liquidity today. This is similar to the rush of adrenaline that one might experience when hiking in the woods and being suddenly confronted by a mountain lion. You will run fast and hard but how long can you keep it up? This much is certain - not forever.

I expect that a strong dose of reality is going to come to the markets in the coming weeks - perhaps this week.

If not now, certainly if next month's same-store sales show further weakness, or if there's no evidence of a strong pickup in the housing sector. If the consumer falls out of bed, then its "look out below!" And honestly, I don't see how it can be avoided. As debt shifts to higher-interest-rate instruments, a shift that has been going on now for a few months and is only going to continue.

Worst-case, second quarter earnings are going to be fun to watch, but I suspect we're going to start seeing warnings sometime around the end of May, which is just a few short weeks off. Right now guidance is being maintained by retailers, which looks to me to be a brave face on what is almost certain to be a nasty reality - if same-store sales continue to be weak then how can you maintain guidance for earnings growth? It looks to me like everyone is trying to believe that April's numbers were a "glitch" - I'm not buying it.

I would love to see the the counterpoint to this - how does the consumer continue to spend at an increasing pace when their debt is shifting to higher-interest instruments and total debt load continues to rise?

If that's all there is, we should see a "walking down" of the markets - not a dramatic crash - but losses nonetheless. The Fed might be tempted to cut interest rates, but how can they while real inflation rates are in fact quite high and while other governments are raising rates? If the Fed cuts rates in that environment it results in a flood of capital out of the US and into foreign debt instruments with better yields, which causes bonds to sell off hard - real interest rates go up even though the Fed cut rate and the dollar tanks at the same time!

The only way I can see the Fed getting out of this box is to somehow convince foreign central banks to cut rates in tandem with the Fed. This I rate as highly unlikely, because foreign bankers are increasingly concerned about inflation - as well they should be.

What could provoke an outright crash is fallout from the credit markets. If foreclosures and other mortgage defaults spike further, that could initiate it. A far more ominous development would come in the form of a failed LBO deal or, with continued softness in the economy, a spike of defaults in the commercial credit markets. China may choose to "take its pain now" rather than risk a market blowup just before (or worse, during!) the '08 Olympics, drawing down liquidity there and spreading the damage here.