UPDATE: Stocks Near Record Highs as GDP Goes Negative

Editor's Note: We're back up and running with a new computer, after ten days of muddling through with three old Macs.

Wednesday was a pivotal day for US stocks as the government reluctantly reported that GDP shrank in the fourth quarter (remember, hurricane Sandy will be blamed for disappointing holiday retail sales) as defense spending fell by the largest amount in 40 years and inventory growth lagged.

The talking heads across the CNBC and Bloomberg networks blamed the "unexpected" decline of 0.1% mostly on the defense spending, a result of congress' inaction on the budget process and potential for sequester cuts to kick in shortly.

Federal Reserve officials, completing a two-day meeting, noted the economy had "paused" due to weather-related disruptions and other "transitory factors." Nothing like a Fed Open Market Committee that continues to furiously pump dollars into the coffers of the banks and keep interest rates artificially low calling climate change "disruptions" and employing the "transitory" verbiage to mask an incredibly weak nominal economy.

What is not so well hidden in the report is the lack of replenishment of inventories. Through the holiday season, retailers were adamant about reducing overhead, slashing prices and keeping costs to bare-bones levels, opting to wait until later to order new goods. The lack of confidence going forward exacerbates the slow "recovery" further, putting pressure on manufacturers (those few remaining on US shores) to cut prices and make concessions on delivery and payment dates and rates.

The setup is deflationary at worst, erratic at best, but continues to point up issues developing from the federal government's plan to kick the fiscal can down the road a bit further instead of tackling the nation's debt and deficit problems head-on.

As for stocks, they did an about-face after the Fed's afternoon announcement that they would change absolutely nothing, reiterating their intent to purchase $85 billion a month in MBS and Treasury issuance, the inflationary frontage against the winds of stagnation. The Fed also will keep rates artificially low, boosting home sales, but doing little for bank profits. Their attack on the monetary system continues to hamper business investment while inflating real estate through low interest rates. With no exit strategy in place, the only place the Federal Reserve and the government are kicking that can of deflation is directly into a brick wall of deflation and recession. The negative GDP print for the fourth quarter of 2012 is exactly what their policies will produce down the road, though the decline will be vastly greater.

It's important to note that with one quarter of negative GDP already on the books (though revisions will likely change that to a positive integer), another consecutive quarter in the red is the textbook definition of a recession. Regardless of whether the downturn is isolated in one or two areas, the overall picture remains clouded, manipulated and quietly desperate.

There's no good way out of a financial crisis, such as that which occurred in 2008, but the Keynesians in Washington have kept the plates spinning, frantically turning the sticks of quantitative easing and heavy-handed deficit spending. These policies have an end at some point, the question being whether the end will come by their own hands or be forced by the merciless invisible one of Mr. Market.

Optimists will point out - correctly so - that even though the economy is staggering along, it is still vibrant and productive. However, to think that corporate profits are a one-way street to the heavens is a folly on par with thinking the sub-prime housing bubble would never burst.

There's going to be a short-term pullback in both housing and stocks, both having been bid up too high, too fast, on artificial stimulus, a condition approaching that of 2005-07. While the near term cannot be characterized as horrifying, it is most certainly unstable and unsure, and profits will be taken at nose-bleed levels. The chances of a short duration correction are high, those of a cyclical turn to a bear market less likely, though the current bull is now entering its 48th month, worth noting that the turn in 2007, which led directly to a crash in the fall of 2008, was on the heels of a 53-week-long bull run.

Out in the fantasy land known as economic and stock market predictions, the sounds are of quiet groaning accompanied by squeamish forecasts of 2% growth in GDP for 2013 and an S&P ramping toward 1550. While the general public and regional economies twist in the wind under the thumb of higher taxes and tighter regulations, making business development a non-starter, Wall Street will continue to binge on the Fed's free money, the punch bowl that Chairman Bernanke will not take away, and the government debt will continue to be monetized by that same Fed.

Both of these conditions cannot continue indefinitely, but those in control continue to deny the possibility that anyone will feel any economic pain, no matter how slight.

Thus, it would not be at all surprising to see stocks continue to rise in the face of stagnant or deteriorating conditions in the real economy. Either the stock market wakes up to reality or the current bull trend will wind up being the longest in recorded history, all built on an inflationary bubble of the Fed's creation.

It is false to believe that these conditions can continue indefinitely. There is a price to be paid for every manipulation and falsehood presented to the markets and the fallacy of current policies suggests that the price will be enormous.