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Tony Fratto: Wall Street's Relief Rally

Cash for clunkers isn't just at the auto dealer on Main Street—it's also available on Wall Street.

Wall Street traders
CNBC.com
Wall Street traders

Investors are ponying up cash for clunkers of stocks, with willful disregard for weak underlying fundamentals.

With all due respect to my sage elders, Larry Kudlowand Dennis Kneale, this rally will stall. Not because America isn't still the best place in the world to do business—it is—but because we've got real problems and risks that we'll only work through over time. America will still lead growth, just not right now.

This is a relief rally. It reflects the euphoria of having survived a near-death experience. The market dived fast and hard in the face of calamity and talk of a second "Great Depression". Now that it's clear the end is not near, investors are a bit more confident and can make some money with the survivors—firms that are now leaner, are more productive, and have even lost some competition in the carnage of the last year.

But a sustained rally still needs support from underlying fundamentals and economic growth, and evidence of any lasting support is barren.

What's lacking in fundamentals?

Consumers.

Consumption is 70% of GDP, and consumption is a function of jobs and income.

Unemployment is climbing toward double-digits, and will likely stay elevated through 2010. And yesterday's income and spending data were downers. Personal income fell by the fastest rate in years. Headline spending surprised, but a deeper look shows the increase came from consumers paying higher prices for a necessity—gasoline purchases—and paid for by drawing down savings. Hardly an indicator of a robust consumer.

Housing, despite the recent cheery pending home sales data, will also continue to be a drag on consumption. Personal bankruptcies are at record highs and foreclosures are still climbing. Even if housing hits a bottom, the housing supply overhang is so big that it will take years—not months—to revert to the mean on prices. Millions of homeowners will be upside-down on their mortgages for a very long time.

Furthermore, even the government's limited effort to modify mortgages is only masking a problem and delaying the inevitable in most cases. Data show that about two-thirds of homeowners receiving modifications are back in default nine months later. Housing will take time to recover. Probably a long time.

Credit—both for home mortgages and revolving credit lines—will also be a brake on growth. The multiplier the economy derived from easy credit is absent today, and maybe gone for a generation. Even if financial firms could return to offering easy credit (they can't), consumers have become risk averse and are exceedingly unlikely to re-leverage to rates we saw in the boom years.

The economy is surviving on a sugar high of Fed easing and some stimulus spending—neither of which will last.

So what about those clunkers investors have been snapping up? I'd be careful about taking them out for a drive. Many of the companies reporting better-than-expectations did so because of one-off savings and accounting changes.

Companies that survived the panic will make some profits in the short-term. They're road-ready. They're stripped down and tuned up, and they'll be great American roadsters for the long-term.

But for now, without fuel in the tank, expect to see them parked in driveways for awhile.

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Tony Fratto is a CNBC on-air contributor and most recently served as Deputy Assistant to the President and Deputy Press Secretary for the Bush Administration.