Today’s economic report by David Rosenberg was full of insightful nuggets. If you haven’t subscribed yet, I strongly suggest you do while it’s still free. No telling how long it’ll stay that way. Excerpts:

On this rally and equity valuations

The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation — usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs — during this extremely flashy move, the U.S. has shed 2.5 million jobs (as may as were lost in the entire 2001 recession).

This is an overbought and overpriced equity market and we remain of the view that there is too much risk and too much growth being discounted to be a full participant.

On Gold

The U.S. dollar is weak and that is helping maintain a positive tone to the gold price. Imagine that, bullion is north of $1,000/oz at a time when the U.S. CPI is -1.5% YoY — imagine what gold will do if (when?) that inflation rate turns positive.

On Inflation/CPI Data

While the bond market sold off yesterday, one has to be encouraged by the CPI data. The core was only +0.1% MoM for the second month in a row (actually, August was +0.07%). Even adjusting for Cash-for-Clunkers, the core would be 0.16%, so still very tame. Many sectors are having trouble seeing much in the way of any pricing power in the retail sector. The YoY headline inflation rate, even with the recent boost from energy prices, is running at -1.5% YoY. And, the core index, which excludes food and energy, is now down to +1.4% and within distance of taking out the 2003 low of 1.1%.

Inflation does appear to be tame for now (at least according to government stats). My fear is these readings will only encourage more QE, bailouts, and deficit spending. It is nearly impossible for me to imagine Bernanke and Geithner allowing sustained deflation to occur. Given a choice between paying off our debt in cheap or costly dollars, which do you think they will choose? This argument assumes Fed and Treasury have the tools to initiate inflation, which many doubt. I’m betting they’ll find a way to make it happen.

So while I have a huge amount of respect for Dave Rosenberg, it’s hard for me to imagine his deflationary scenario taking place with Bernanke at the helm. Current economic policy calls for max-bailouts, liquidity-pumping, and plenty of book-cooking via changes to accounting rules and inflation data. See Flaws in the Deflation Case for more.

As Bill Fleckenstein says, “In a social democracy with a fiat currency, all roads lead to inflation“. I remain in Fleck’s camp (inflationary), but am constantly examining arguments to the contrary. Why? If I’m wrong and an deflationary collapse (like the one sketched out by Karl Denninger and others) happens, things could get very ugly, very fast.

Disclosure: Long Gold. No other positions in companies mentioned.