Talking to an old friend about the US economic “recovery,” we see no profit growth from extremely discounted levels, no revenue growth, and no employment growth.

We see more than 100% of GDP growth as completely dependent on government(s) spending.

The Federal Housing Administration has issued more than a trillion dollars in mortgages this year, picking up where Fannie Mae and Freddie Mac left off (they really haven’t stopped either). Delinquency rates are approaching 17%.

Real GDP may be positive for the quarter, but when the government is involved there are lots of shenanigans.

For example, we've heard it plans to deduct the cash rebate for cars from the sales price, thus lowering the GDP deflator and artificially raising the reported real GDP number.

Senseless.

It’s all a game of perception. An economy is a physical system, and in the long run it will react as such.

Recent history has seen economic growth stimulated by government(s) artificially lowering interest rates to get the consumer to borrow, which leads to companies building inventory, which leads to hiring, which leads to economic expansion.

This time around, the consumer is so levered that will not happen. The Fed itself has worried about this in papers as the “zero bound interest rate problem.”

This is a balance sheet contraction, a credit bust. You even hear the government saying it'll take years to recover. It'll take years for the consumer to delever (unwillingly).

I think most stock buyers know this, but aren't buying stocks because they think the economy will recover and profits will too.

I think a lot of people are buying stocks to 1. catch up with other buyers, and 2. because they're worried about “inflation".

I've written in detail why inflation (credit expansion) is unlikely: The fractional banking system is still broken, and so is the consumer. Without either or both, every dollar the Federal Reserve attempts to print just replaces a dollar destroyed by bad debt.

I estimate another $10 trillion to $20 trillion in debt/derivatives is still bad. The government is resurrecting PPIP to try to make that debt look better.

But again, an economy is a physical system.

When the market realizes that the Fed can't create inflation (a full monetization of the majority of debt; something that would make even Ben blink), it'll see that the S&P 500 is really trading at 20 times earnings that are not growing.

It'll realize that all we've done is actually increase the overall debt in the system with massive stimulus and spending.

It'll see the risk in stocks as extremely high.