It’s amazing that stocks have held up they way they have. Ostensibly, the market’s advance has occurred in anticipation of the economy recovering, but for all the talk of “green shoots” a few months back, the evidence that the economy is indeed improving remains decidedly thin.

Yes, there may be signs of life in the economy here in the later part of the third quarter and the early going of the fourth quarter thanks to massive government spending and some inventory rebuilding, but we fear this will prove fleeting. This week’s ISM manufacturing index reading was good, for instance. I’ll remind you that this has been a credit-driven recession, however. Recoveries following such recessions tend to be slow drawn out affairs.

The credit market, which dwarfs the stock market, is unequivocally pointing to continued economic weakness. U.S. Treasury bills fell to their lowest level the other day in the 50 plus years records have been kept. Long-term yields, likewise, have failed to move higher as is normally the case coming out of recession.

Banks aren’t lending, period, which is why the money supply isn’t growing. And consumers are is such bad shape they aren’t likely to lend a meaningful hand with the recovery anytime soon. Early indications point to the back-to-school shopping season tuning into a bust. Credit card defaults ticked down ever so slightly in July, after five months of record highs, prompting some to see signs of hope. But while things appear not to be getting any worse for now, defaults typically track unemployment which is set to rise further in the coming months. The U.S. dollar continues to trade near its lows for the year. The buck appears to be marking time before heading lower. And the only thing likely to cause a temporary reversal would be a big selloff in equities which would bring about a resumption of the safety trade.

Rising commodities, and in particular oil, is another threat to the recovery. While some event is likely to be seen as the trigger for a setback in equities, keep in mind the market may simply collapse under its own weight. Valuations are quite steep, trading at an extremely high multiple of 2010 profits—profits that will require GDP growth of 5 percent or more to achieve. Keep in mind that profits have fallen short of expectations by a wide margin in five of the last eight quarters, so I see little reason for Wall Street to get things right in the coming year.

Wall Street isn’t alone in its (misguided) enthusiasm. Measures of investor sentiment have surpassed the levels that prevailed at the market’s top in October, 2007. Taken as a group, small investors are typically far too bullish at tops and overly bearish at bottoms. Corporate insiders, meanwhile, can’t sell their company stock fast enough. According to the tracking service Trim Tabs, insiders have been net sellers of a record $105.2 billion is shares during the past four months. Perhaps they know something about their companies’ prospects that the little guy has missed. I can’t pinpoint when the selloff will occur: It may get underway at any time, or stocks may hang in there for a couple of weeks before retreating. I am confident, however, in predicting that it will be a spectacular rout. So watch out below...

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