Forget GDP. Tax revenue tells the real story.

Mish often points out that state sales taxes are flat to down year over year, even though rates are up, revealing that the recovery is all smoke and mirrors. Zerohedge has been reporting the federal income tax withholding data, which tells much the same story. Basically, if the economy were really improving, people would be earning more, spending more, and paying more taxes. Government spending is not economic growth — if it were that easy, the USSR would still be around.

Here’s the latest withholding data from zerohedge:

3rd Quarter GDP revised lower again

The bulls cheered when the Department of Commerce told us GDP was 3.5%, but then the estimate was quietly lowered to 2.8%, and now we hear that 2.2% is a more like it. In reality of course, when you take away government expenditures, which should not be in GDP anyway as they are not Production, the economy continued to shrink. What else would you believe given that credit is still rapidly contracting and government is throwing sand into any market mechanisms that would clear away the bad debt?

Interesting juncture in sentiment

We reached a point this week where almost all bears turned short-term bullish at the very least, if they didn’t swear off shorting altogether. Hordes of hobby bears were crushed over the last three weeks, and even hard core bears from before 2008 seemed to adjust their wave 2 targets upward as high as SPX 1200.

I took that as a sign of short-term weakness at the very least, so in addition to my regular purchase of December 2011 puts, I added a few March QQQQ puts and October 09 calls on the 10 year note. This AM I also took another stab at picking a top in copper at 2.60, with a 2.62 stop.

The reaction to GDP so far has been encouraging, with futures traders not buying the BS that the economy only shank at a 1% pace, since the surge in government spending gave it a phony boost. Since there is no P in government, why is government in GDP? GDP can go as high as the Feds want. All they have to do is spend and have the central bank monetize whatever bonds the market won’t absorb. This chicanery, plus inventory replacement, could bring a slightly positive number in Q3, ironically just as TTM S&P 500 earnings go negative for the first time since they started keeping records in 1936.

I see no reason to change my guess that the end of wave 2 is nigh. I have been thinking since spring that 1050 or September, whichever came first, would be the signal that the top was in. It could be in already, but don’t expect things to drop off a cliff right away. A wave of this magnitude rolls over slowly, with plenty of smaller breaks and rallies before the trend has solidly reversed.

Keep an eye on the credit markets. When fear comes back in earnest, corporate bond spreads will break their relentless slide downward, and short to intermediate term Treasuries, if not the 10-year and 30-year, will signal a renewed flight to safety.