If you have not yet read Part I: When Will Reality Intrude and the Stock Market Hit Bottom?, available free to all readers, please click here to read it first.

In Part I, we explored the correlation between the stock market and the real economy (tenuous in times of massive intervention) and the probability that the economy’s next trough lies between 10 and 30 weeks in the future.  We then looked to Japan’s Nikkei stock market index as a guide to equities’ performance in eras dominated by debt and deleveraging, and found that the Nikkei’s history suggests a bottom in U.S. stocks could be as far as a year away, in mid-2013.  This aligns with the possibility that the real economy hits a recessionary bottom in late 2012 and the stock market finally reflects that weakness six months later in mid-2013.

As we look at other evidence supporting a significant decline in stocks, we must keep Part I’s caveats firmly in mind:

1. It’s possible that equities could rise to previous highs or even reach new highs in the near term, despite the recessionary stagnation of real incomes and growth, as stocks tend to be “lagging indicators” of recession.
2. Massive monetary easing and fiscal stimulus could push “risk-on” assets (such as stocks) higher, even as the real economy weakens.
3. Global Corporate America could continue generating profits that would support stock market valuations even as the bottom 80% of U.S. households sees further deterioration in their real incomes and balance sheets.

These three factors could support a decoupling of the stock market from the “main street” economy as measured by real (inflation adjusted) incomes and household balance sheets.