LIFE GOES ON IN THE SERENGETI

U.S. Market & Economic Chart Stack

Jeb B. Terry, President
Aberdeen Investment Management, LLC
As of November 10, 2010
jbtsr@aberdeeninvestment.com www.aberdeeninvestment.com

Caution: It’s a risky world we live in. My opinions are based on information believed to be reliable but
hey, I could be wrong. When investing, try to use good judgment and don't hesitate to seek
professional assistance. Remember to set limits and have a plan. . . Good Luck!
Nov 10, 2010

Page 1 of 58
 LIFE GOES ON . . .
LAST YEAR – IT WAS “RUN FOR YOUR LIVES”!

In 2008 and early 2009, the investing public

was like a herd of frightened wildebeests
running from lions trying not to be the last one
eaten. They dumped their holdings in equity
mutual funds in mind boggling amounts. They
stampeded into the safety of bonds. They
accumulated as much cash as fast as possible.

THIS YEAR – THE HERD IS BACK TO WHAT COMES NATURAL

Yes – there are still lions around – and the
“beests” are on guard – ready to run, but life
goes on. It is the natural state for “beests”
and the economy to be productive.
The Great Recession was a heck of a storm
but it was not the end of life as we know it.
The data increasingly illustrates the
economy and markets are recuperating.
Page 2 of 58
CHECKING THE BOXES

We are in an early phase of sustainable economic and market recovery.

The leading indicators are pointing up.
Jobs are recovering.

The consumer is better off.

Residential housing is starting to recover.

Profits and business investments are recovering.
The banks are able to lend.

Interest rates and monetary data are signaling improvement.

We are not drowning in debt.

Stocks are incredibly cheap.

Political change is good for stocks.

We are in a golden age of innovation.

Page 3 of 58
KEY POINTS

 Equities Still in Early Recovery 6

 Regression to the Mean 7

 Abundance of Fear, Absence of Greed => Good Time to Invest 8

 The Leading Indicators Remain in an Uptrend 12

 GDP Growth is Returning – Productivity is rising 14

 Jobs are Improving 17

 What about the Consumer? Debt down, Savings Up 21

 Is the Housing Bust Over? 25

 A Profits & Investment led Recovery 29

 What about the Banks? Getting back into lending mode 37

 Interest Rates and Monetary Data Signal Recovery 40

Page 4 of 58
 Fed Monetary Policy – „W – I – T” = Whatever It Takes 45

 MV=PQ” . . . Money Supply x Velocity = Price x Real Output 46

 Investors Yield Starvation = Borrowers Interest Bargain 49

 What about the Growth in Debt? 51

 The Model Says Stocks are Incredibly Cheap 53

 There is Change in the Wind . . . Good for stocks in 2011 55

 Are We Possibly on the Cusp of a “Golden Age”? 56

THE “BEESTS” ARE GRAZING – LIFE GOES ON

AVOID BONDS – BUY STOCK – BETTER DAYS LIE AHEAD

Page 5 of 58
EQUITIES STILL IN EARLY RECOVERY

S&P 500 LONG TERM TREND STILL UP

PRICE HISTORY: 1926 TO PRESENT
PRICE INDEX 1926 = 100 [Log Scale]

The S&P 500 remains well 12,928

above its long term trend.
2,725
1,000
1,000
9,959
265 538
152

38

1
26
31
36
41
46
51
56
61
66
71
76
81
86
91
96
01
06
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
So . . . capital always seeks a return, just as the wildebeests will always
migrate around the Serengeti, some will be lion food but most will
succeed, procreate and sustain the herd.
Page 6 of 58
REGRESSION TO THE MEAN
The statistical likelihood is that the next 10 years should be much
better.
S&P 500
PRICE HISTORY: 1926 TO PRESENT
10 Year % Change 10 year % Change - Linear Regression
450%
400% 369%
350% 313%
300% 272%
250%
200%
150% 87%
100%
57% 88%
50% 29% 34%
0% -11%
-25%
-50%
-58%
-100%
26
30
34
38
42
46
50
54
58
62
66
70
74
78
82
86
90
94
98
02
06
10
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
Gains are far more frequent than losses. The mean 10 year return since 1926
is 107%. The mean 1 year return since 1926 is 8%.

Page 7 of 58
ABUNDANCE OF FEAR, ABSENCE OF GREED
=> GOOD TIME TO INVEST

WE ARE
HERE

Investors are working their way through the psychological impact of the
2008/2009 panic in the markets.
The implication: We are at a point of “maximum financial opportunity”.

Page 8 of 58
The public‟s willingness to hold unprecedented levels of “money of zero
maturity” not to mention “money of zero yield” is a dramatic expression of
the complete absence of greed in the market today.
U.S. Nominal GDP vs. Money of Zero Maturity
1969 to Present
MZM % of GDP MZM Nominal GDP Median MZM % of GDP
$14,800 150.0%
$15,000
$12,500 125.0%
$9,537
$ Billions

$10,000
$7,500 100.0%

$5,000
64.4%
75.0%
$2,500 56.6%
$0 39.8% 38.7% 50.0%
31.6% 41.4%
-$2,500
25.0%
-$5,000
-$7,500 0.0%
D -69
D -71
D -73
D -75
D -77
D -79
D -81
D -83
D -85
D -87
D -89
D -91
D -93
D -95
D -97
D -99
D -01
D -03
D -05
D -07
9
-0
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
ec
D

Sources: St. Louis Fed, Dallas Fed

Page 9 of 58
There has NEVER been as much money paid into any type of mutual
fund in any single year as went into bond funds last year!

Equity vs. Bond Mutual Fund Net New Cash Flow

Equity Bond
$500
Unprecedented
Unprecedented $375
$400 move into retail
move into retail
$309 bond funds
equity funds
$300
$215
$200 $140
$ Billions

$100

$-
$(11) $(15)
$(100) $(65) $(50) $(28)
Unprecedented
$(200) move out of retail
equity funds
$(300) $(238)
90

92

94

96

98

00

02

04

06

08

10
19

19

19

19

19

20

20

20

20

20

20
The move is predictive of a top in the bond market and a relative low in
the stock market.

Page 10 of 58
 It’s hard to have a margin call when there isn’t much margin debt . .
. Tops don‟t occur when margin debt is modest – as today – which resembles
where we were in 2004, the early phase of a three year bull market.

MONTHLY NYSE MARGIN DEBT

2000 TO PRESENT

$450,000
$400,000 $381,370
$350,000
$300,000 $278,530
$ Millions

$250,000 $235,748
$200,000
$150,000 $173,300
$100,000 $130,210
$50,000
$-
0 1 2 3 4 5 6 7 8 9 0
n -0 n -0 n -0 n -0 n -0 n -0 n -0 n -0 n -0 n -0 n -1
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja

A sharp increase in margin debt, as in 2007 in the chart, signals a top in the
equity market is at hand . . . that is NOT the case today.

Page 11 of 58
THE LEADING ECONOMIC INDICATORS REMAIN IN AN UPTREND

ECRI Weekly Leading Economic Indicators

2000 to Present
6 Month % Change-Positive 6 Month % Change-Negative
Weekly Leading Eco Indicators (left scale) 6 Month % Change

145 50%

135 40%

30%
125
120.4 20%
115 115.3
112.8 10%
105 105.5 0%
95 -10%

85 -20%
0

0
-0

-0

-0

-0

-0

-0

-0

-0

-0

-0

-1
n

n
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja
The weekly economic indicators published by the Economic Cycle Research
Institute are still signaling a recovery.
Page 12 of 58
The drop in the economy was steeper and the recovery has been faster
and stronger.
Weekly Leading Economic Indicator Trend in Recovery
Weekly % Change in LEI
Beginning of Recovery = 100
Economic Cycle Research Institute
2009 Recession Recovery 2001 Recession Recovery
1991 Recession Recovery
130

120

110

100

90
W k 17
W k 33
W k 49
W k 65
W k 81

ee 7
ee 3
ee 9
ee 5
ee 1
ee 7
ee 3
ee 9
ee 5
ee 1

7
W k1

W k 11
W k 12
W k 14
W k 16
W k 17
W k 19
W k 20
W k 22
W k 24

25
W ek 9
ee
ee
ee
ee
ee
ee

k
W

Page 13 of 58
GDP GROWTH IS RETURNING – PRODUCTIVITY IS RISING
New Orders Have Led GDP Growth
YOY GDP Growth vs ISM Mfg New Order Index
Nominal GDP
ISM Mfg New Order Index - 4 quarter Average
14% 80

ISM Mfg New Orders Difussion

13% 75
Year Over Year % Change in

11% 70

Index 50+ = Expansion

10% 65
Nominal GDP

8% 60
7% 55
6% 50
4% 45
3% 40
1% 35
0% 30
-1% 25
-3% 20
2

0
-8

-8

-8

-8

-9

-9

-9

-9

-9

-0

-0

-0

-0

-0

-1
ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar
M

M
The relationship of ISM New Order growth and GDP growth suggests
nominal GDP growth north of 5% as we proceed toward 2011.

Page 14 of 58
 Productivity Leads GDP Growth
Nominal GDP vs. GDP/Employed
Year Over Year % Change

Nominal GDP 4 per. Mov. Avg. (GDP / Persons Employed)

14.0% 10.0%
Change in Nominal GDP

12.0%

Chnage in GDP/Person
8.0%
10.0%
8.0% 6.0%

Employed
6.0%
4.0%
4.0%
2.0% 2.0%
0.0%
0.0%
-2.0%
-4.0% -2.0%
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
Spikes in productivity have also signaled rebounds in GDP growth.

Page 15 of 58
Ample unused capacity means no double dip, low inflation risk, more
productivity growth and more profit expansion to come.

Source: First Trust

Page 16 of 58
JOBS ARE IMPROVING
YOY Change in Persons Employed 1958 to Present
Year Over Year Change - Thousands Establishment vs. Household Survey
Household Survey
Establishment Survey
6,000

4,000

2,000 819
-
829

(2,000)

(4,000)

(6,000)

(8,000)

Source: Bureau of Labor Statistics

More people were laid off in the recent recession than ever before. The
number of persons employed has begun to grow.

Page 17 of 58
 % of Population Employed
1980 to Present
Median % of Population Employed
12 Month Moving Avg. % of Pop. Employed
50%
49% 48.8% 48.8%
48% 48.2%
47% 47.5% 47.23%
Percent

46% 46.3%
45% 45.16%
44%
43%
42.6%
42%
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
Source: Bureau of Labor Statistics, Census Bureau

Drop in the percentage of the population employed = excess labor

capacity => subdued wage inflation. Baby Boom Echo generation will be
hitting its peak labor force impact over the next 3-5 years.
Page 18 of 58
 American Staffing Association
Staffing Index
12 per. Mov. Avg. (Staffing Index)
6 per. Mov. Avg. (Staffing Index)
120

110 110
June 12,2006=100
Index Value

100 100

90

80

70
71
60
06

O 7

O 8

O 9

10
Ju 7

Ju 8

Ju 9

Ju 0
6

Fe 7

Fe 8

Fe 9
0

0
0

1
-0

-0

-0

-0
n-

b-

n-

b-

n-

b-

n-

b-

n-
ct

ct

ct

ct
Ju

Fe
O

The data for temporary help and overtime also are consistent with rising
employment.

Page 19 of 58
A fly in the ointment . . . small business isn’t hiring . . . small business
is terrified of Obamacare and taxes.

Page 20 of 58
WHAT ABOUT THE CONSUMER? DEBT DOWN, SAVINGS UP

12 month Saving up to
$650+ billion,
Borrowing now
liquidating by $100+
billion.

STILL HOARDING CASH

M1 SINCE 1970
Aug-10

Sept/Oct 2008
$2,000 Financial Melt Down
$1,800 9-11-2001 $1,743
In addition to paying down $1,600
Terrorist Attack

debt the consumer has $1,400

$1,175
$1,400
$Billions

$1,200
$1,208
been accumulating cash. $1,000
$800
$792
$600
$381
$400
$204
$200
$-
Se -72

Se -79

Se -86

Se -93

Se -00

Se -07
M -70

M -77

M -84

M -91

M -98

M -05
Ja 74

Ja 81

Ja 88

Ja 95

Ja 02

09
p-

p-

p-

p-

p-

p-
ay

ay

ay

ay

ay

ay
n

n
Ja

Source: Federal Reserve, Not seasonally adjusted

Page 21 of 58
 Personal Income vs Spending 1990 = 100
Disposable Personal Income
Personal consumption expenditures
300

270 262 264

262
240
Remarkable recovery in
210
personal income and
258
180
spending. Now at new
150
highs.
120

90
0

8
-9

-9

-9

-9

-9

-0

-0

-0

-0

-0
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

D
Rebuilding Liquidity: Months of PCE Held as Cash,
Savings Dep & Retail Money Market Funds
1980 to Present
11.5
11.2 11.1
Over 10 months of 10.8
10.3
Months - M2 10.5 10.3
personal consumption 10.1
10.03
9.8
expenditure held in 9.4
9.4
9.1
cash and equivalents. 8.7
8.4
8.5
8.0
0

8
-8

-8

-8

-8

-8

-9

-9

-9

-9

-9

-0

-0

-0

-0

-0
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

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D

D
M2 includes a broader set of financial assets held principally by households. M2 consists of M1
plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-
denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in

Page 22 of 58
2009 saw the 2nd largest one year dollar gain in retirement account value
in history.

Retirement Accounts & Cash vs. Nominal GDP

1985 to Present
Retirement & M1 & Retail Money Market Funds Nominal GDP
$25,000

$20,304
$20,000
$18,675
$16,651
$ Billions

$15,000 $14,700

$10,000

$4,319.3
$5,000

$3,123
$-
5

9
-8

-8

-8

-9

-9

-9

-9

-9

-0

-0

-0

-0

-0
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

D
The naysayers are right to some extent . . . the U.S. consumer isn’t
a saver . . . he’s an investor the likes of which has never been
seen in recorded history.
Page 23 of 58
We have more people in the prime ages for employment, consumption
and investment than ever in our history.

NUMBER OF PEOPLE REACHING AGE 49

VERSUS AGE 18 AND 25
1954 TO 2018
49 YR OLDS 18 YR OLDS 25 YR OLDS
5.0
4.8
4.5
MILLIONS OF PEOPLE

4.3
4.0
3.8
3.5
3.3
3.0
2.8
2.5
2.3
2.0
54

58

62

66

70

74

78

82

86

90

94

98

02

06

10

14

18
19

19

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20
Page 24 of 58
IS THE HOUSING BUST OVER?
US Median Home Price

220,000
$213,600
210,000

200,000

190,000
Up 9% from the low.
$183,500
Median home prices appear
$181,900
180,000
$179,300
to have found the floor.
170,000

160,000 $164,200 $169,300

150,000
7

Au 8

O 8

Fe 8

Au 9

O 9

Fe 9

Au 0
10
08

Ap 9

Ap 0
Ju 8

D 8

Ju 9

D 9

Ju 0
0

0
-0

-0

-0
r-0

-0

0
r-0

-0

1
r-1

1
g-

g-

g-
b-

n-

b-

n-

b-

n-
ec

ec

ec
ct

ct
Ap
Fe
D

Source: Natl. Assoc. of

Realtors www.realtor.org

US Housing Affordability Index

180.0
Home affordability has never 160.0 154.8
Best Since 1970 163.8

been higher since the Boomers 133.2

140.0
began to hit the home buying
120.0
population.
100.0 106.1

80.0

60.0 68.9
70

73

76

79

82

85

88

91

94

97

00

03

06

09
19

19

19

19

19

19

19

19

19

19

20

20

20

20
Source: Natl. Assoc. of Realtors
www.realtor.org

Page 25 of 58
 Trailing 12 Month Housing Permits
1959 to Present
LTM Average Permits
2,500
2,300
Permits - Thousands

2,100
1,900 Housing permits have
1,700
1,500 apparently found a floor.
1,300
1,100
900 982.5 934.7
854.2 865.7 607.6
700
500
Ja 59
Ja 62
Ja 65
Ja 68
Ja 71
Ja 74
Ja 77
Ja 80
Ja 83
Ja 86
Ja 89
Ja 92
Ja 95
Ja 98
Ja 01
Ja 04
Ja 07
10
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
Ja

Monthly Housing Permits vs New Jobs

1959 to Present
12 per. Mov. Avg. (YOY Change in # Employed)
12 per. Mov. Avg. (Total Housing Permits)
250 8,000
6,000
Permits (and starts) won’t

Persons - Thousands
Permits - Thousands

200 4,000
fully recover until job growth 150
2,000
-
is restored. (2,000)
100
(4,000)
50 (6,000)
(8,000)
0 (10,000)
Ja -59
Ja -62
Ja -65
Ja -68
Ja -71
Ja -74
Ja -77
Ja -80
Ja -83
Ja -86
Ja -89
Ja -92
Ja -95
Ja -98
Ja -01
Ja -04
Ja -07
10
n-
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
Ja

Page 26 of 58
The surplus of new homes has already been substantially worked off.

Housing Start Surplus

2000 to Present
Excess <Deficit> Starts vs Median Annual Housing Starts
Cumulative Surplus Housing Stock Potential Housing Starts
1980 Median Starts
3,000
2,500 2,371
2,068
2,000 1,805
Thousands Starts

1,500 1,474
1,264
1,000
594
500 331
555
0
-500
-460
-1,000
-920
-1,500
80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

10

12
19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20
Page 27 of 58
So . . . Why should a tech investor like me care about housing data?
It means that TRILLIONS of dollars will no longer be pushed into
excess housing stock and will therefore be looking for productive returns
elsewhere.

Mortgage Related Bonds Issued in U.S.

as of September 2010
$3,500
$3,071
$3,000
$2,500
$2,050 $1,957
Billions

$2,000
$1,500 1,578.9
$1,000
$1,340

$500 $684
$493
$-

10
96

97

98

99

00

01

02

03

04

05

06

07

08

YT 009
20
19

19

19

19

20

20

20

20

20

20

20

20

20

2
D
Includes GNMA, FNMA, and FHLMC mortgage-backed securities and CMOs and private-label
MBS/CMOs.
Sources:U.S. Dept of Treas, Fed Agencies, Thomson Financial, Inside MBS & ABS, Bloomberg.

Page 28 of 58
A PROFITS & INVESTMENT LED RECOVERY

Corporate Profits on the Mend

1972 to Present
(Seasonally Adj. Annual rates per NIPA)
Linear (Corp Profits -NIPA $ Billions SA Annual Rates)
$2,000

$1,750 $1,655.1 $1,614.1

$1,500
$ Billions

$1,250

$1,000 $912.0
$995.0
$750
$765.0
$500

$250

$-
Ju 72
Ju 74
Ju 76
Ju 78
Ju 80
Ju 82
Ju 84
Ju 86
Ju 88
Ju 90
Ju 92
Ju 94
Ju 96
Ju 98
Ju 00
Ju 02
Ju 04
Ju 06
Ju 08
10
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
Ju

Source: Bureau of Eco Analysis. National Income and Product Accounts.

Corporate profits have recovered 2.5X faster than the average of the
last 3 recessions.
Page 29 of 58
Industrial production and earnings are in strong recovery mode. The
following series of charts from Yardeni.com illustrate strong growth and tight
correlation of earnings, industrial production, European growth and jobs.

Page 30 of 58
The U.S. is not alone . . . Europe is also in recovery despite what you heard
last summer.

Page 31 of 58
Earnings and industrial production lead to jobs – earnings growth will
slow but remain above 20% and strong enough to support job growth.

Page 32 of 58
Earnings coming from all sources – earnings growth is broad based,
strong contribution from the “Rest of the World” which has approximately
doubled since 2005 to $400 billion.

Page 33 of 58
 Real business
investment showing
signs of recovery.

Equip. & software contribution to GDP growth the highest since 90‟s per
Yardeni.com.

Page 34 of 58
 TECH PULSE INDEX
1990 to Present
12 Month % Change
12 Month % Change-Nominal Dollar Terms
12 per. Mov. Avg. (12 Month % Change-Nominal Dollar Terms)
60% BUBBLE
38.6% BOOM?
40%
20.40%
20%
0%
-20% BUST -18.5%
-40% -31.8%
9

9
-8

-9

-9

-9

-9

-9

-0

-0

-0

-0

-0
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

D
Source: Fed Reserve Bank of SF

The Tech Pulse Index is a summary statistic that tracks the health of the
technology sector. The “pulse” is rising faster than anytime since the
90’s!

Page 35 of 58
 TECH PULSE INDEX VS. NASDAQ
1980 to Present
12 Month % Change
12 Month % Change-Nominal Dollar Terms
43.89%
12 Month % Change-NASDAQ
100%
86.05% 85.78%
80% BOOM
56.87%
60% 53.12% 56.84% 52.46%
40%
19.37% 20.40%
20% 14.09%
0%
-20%
-40%
BUST -40.54%
-60%
-59.21%
-80%
M 0

M 2

M 4

M 6

M 8

M 0

M 2

M 4

M 6

M 8

M 0

M 2

M 4

M 6

M 8
0
-8

-8

-8

-8

-8

-9

-9

-9

-9

-9

-0

-0

-0

-0

-0

-1
ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar
M

Source: Fed Reserve Bank of SF

The last time the Tech Pulse was rising so strongly was in 1995. The
implication: NASDAQ can continue to rise significantly from today’s
levels.

Page 36 of 58
WHAT ABOUT THE BANKS? GETTING BACK INTO LENDING MODE
The massive liquidation of the banks’ loan book, a ~ $400 billion drop in loans,
appears to have stopped. Recovery in C&I loans is critical to the economy reaching
sustained growth.

LOAN BALANCES HAVE STOPPED FALLING

BANK C&I LOANS SINCE 1970
Aug-10

Peak Oct 2008

$1,800
$1,601
$1,600 Peak Dec 2000
$1,400
$1,200 $1,096
$1,224
$Billions

$1,000
$800
$607 $644 $869
$600
$400 $286 Bottom June
$200 $106 2004
$-
J a - 70
J a - 72
J a - 74
J a - 76
J a - 78
J a - 80
J a - 82
J a - 84
J a - 86
J a - 88
J a - 90
J a - 92
J a - 94
J a - 96
J a - 98
J a - 00
J a - 02
J a - 04
J a - 06
J a - 08
10
n-
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
n
Ja

Source: Federal Reserve, seasonally adjusted

Loan growth will pick up when borrowers need the cash for working
capital and when competition for deposits drives up CD rates.
Page 37 of 58
 A MONEY "DE-MULTIPLIER"
M2 vs C&I Loans
Resources and underwriting SINCE 1970
C&I + Real Estate Loans M2
talent will have to find a new $10,000
$8,265 $8,654
source of loan demand for as $8,000

much as $500 billion per year

$Billions
$6,000 $5,431
$4,862
as real estate loans mature (or $4,000 $2,988

default). $2,000
$598
$1,283

$-

Se -72

Se -79

Se -86

Se -93

Se -00

Se -07
Ja -74

Ja -81

Ja -88

Ja -95

Ja -02

09
M -70

M -77

M 84

M 91

M -98

M -05

p-
n-

n-
ay

ay

ay

ay

ay

ay
p

p
n

n
Ja
Source: Federal Reserve,

A report submitted to
Congress marked the total
bad real estate loans at
~$150 billion. This number
will likely grow . . . and the
vultures can hardly wait!

Page 38 of 58
 From February Oversight Report, Comm. Real Estate Losses and the Risk to Financial Stability, 2-10-10

There will be casualties. I

have heard estimates that
as many as 1,000 banks will
be forced to sell out or close
– it shouldn’t hurt the
banking system’s ability
to provide loans to the U.S
economy.
A New Regime in Bank Reserves
Reduces Systemic Risk
Free Reserves vs Loans
Since 1970

C&I + Real Estate Loans Net Free Reserves The FED has taken
$6,000 $5,431 extraordinary steps to
$5,000 $4,862
$4,000 bolster reserves in the
$Billions

$3,000 system growing net free

$2,000
$1,000 $928 reserves from virtually
$-
$(1,000)
zero to nearly $1 trillion.
Ja 0
Ja 3
Ja 6
Ja 9
Ja 2
Ja 5
Ja 8
Ja 1
Ja 4
Ja 7
Ja 0
Ja 3
Ja 6
09
-7

7
7
7
8
8
8
9
9
9
0
0
0
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n-
n
Ja

Source: Federal Reserve,

Page 39 of 58
INTEREST RATES AND MONETARY DATA SIGNAL RECOVERY
The yield curve is STEEP . . . It remains over 2X steeper than average.
The Yield Curve
10 YEAR U.S. TREAS NOTE vs. FED FUNDS RATE
1980 to Present
Yield Curve Histogram 10 Yr Treas rate FED FUNDS RATE
25.0 42.0
% Interest Rate

20.0 35.0

15.0 28.0

10.0 21.0

Yield Curve Histogram

5.0 14.0

- 3.85 3.73 7.0

2.29
(5.0) 0.0

(10.0) -7.0
M -81

M -84

M -87

M -90

M -93

M -96

M -99

M -02

M -05

M -08
Se -80

Se -83

Se -86

Se -89

Se -92

Se -95

Se -98

Se -01

Se -04

Se -07

0
-1
p

p
ar

ar

ar

ar

ar

ar

ar

ar

ar

ar

ar
M

Source: Bloomberg, Federal Reserve

The economy has grown and equity markets have had prolonged
bull phases every time the curve has been this steep.
Page 40 of 58
Since 1971, the NASDAQ has been up 85% of the time following
quarters where the yield curve equaled or exceeded 250 basis points.
The average annual gain has been 14.1% over the following 12 months.
10 Year U.S. Treas. - Fed Funds Yield Curve
vs % Change in NASDAQ
1980 to Present
Yield Curve Histogram Y-O-Y % Change in NASDAQ Price
100 16.0
85.8
80
NASDAQ % Change

14.0
56.8 52.5 56.9
60
36.9 39.9 12.0
40
10.0
20
- 8.0
(20) 6.0

Yield Curve Histogram

(40)
4.0
(60)
2.0
(80)
(100) 0.0
(120) -2.0
Ju 82

Ju 85

Ju 88

Ju 91

Ju 94

Ju 97

Ju 00

Ju 03

Ju 06

9
D 84

D 87

D 90

D 93

D 96

D 99

D 02

D 05

D 08
-0
-

-
n-

n-

n-

n-

n-

n-

n-

n-

n-
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

Source: Bloomberg, Federal Reserve

Page 41 of 58
 THE MOUNTAIN OF MONEY:
MONEY MARKET ACCOUNTS
Since 1980
$4,000
$3,617

$3,000 $2,805.3
$$ in Billions

$2,214
$2,000

$1,761

$1,000

$-
M 80
M 82
M 84
M 86
M 88
M 90
M 92
M 94
M 96
M 98
M 00
M 02
M 04
M 06
M 08
0
-1
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
ar
M

Source: St. Louis Federal Reserve Bank

A reduction in money market funds back to the 14.3% of GDP level of

June 2005 would free up $680 billion from money market accounts.

Page 42 of 58
 REAL FED FUNDS RATE vs CHANGE
IN MONEY MARKET ACCOUNTS
REAL FED FUNDS RATE
Y-O-Y % Change in Money Markets Acct Balances
6.0 60

Y-O-Y % Change in Money Market

5.0 50
Real Fed Funds Rate %

4.0 40
3.0
30

Accounts
2.0
20
1.0
10
-
-
(1.0)
(2.0) (10)

(3.0) (20)

(4.0) (30)
D -9 1

D -9 6

D -0 1

D -0 6
M 87

M 92

M 97

M 02

M 07
Ju 89
Se -90

Ju 94
Se 95

Ju 99
Se 00

Ju 04
Se -05

Ju 09
10
-

-
-

-
n-

n-

n-
ec

p
ec

p
ec

p
ec

p
ec
ar

ar

ar

ar

ar
n

n
D

Source: Bloomberg, Federal Reserve

Money shifts out of money market funds when the real fed funds rate drops
below 0% - like it is now.

Page 43 of 58
 CHANGE IN NASDAQ vs CHANGE
IN MONEY MARKET ACCOUNTS
Y-O-Y % Change in NASDAQ Price
Y-O-Y % Change in Money Markets Acct Balances (Inverted)

MMFunds Y-O-Y % Change (Inverted Scale)

100 (50)
82 (38)
64 56.84 52.46 56.87 (26)
% Change in NASDAQ

46
(13)
28
(1)
10 11.60
11
(8)
23
(26)
(44) 36
(62) Money market fund inflows slow or 48
(80) contract-- Stock prices usually expand 60
M -87

M -92

M -97

M -02

M -07
D -91

D -96

D -01

D -06
Ju 89

Ju 94

Ju 99

Ju 04

Ju 09
Se -90

Se -95

Se -00

Se -05

10
-

-
n-
ec

p
ec

p
ec

p
ec

p
ec
ar

ar

ar

ar

ar
n

n
D

Source: Bloomberg, Federal Reserve

The NASDAQ has been up 81% of the time 12 months following a quarter
when money is leaving money market funds.

Page 44 of 58
FED MONETARY POLICY – “W-I-T”= WHATEVER IT TAKES

The Fed‟s words and actions signal they will do whatever it takes to provide
stimulus and stability. Quantitative easing is the latest initiative.
ECRI Leading Indicators vs. Change in Fed Funds Rate
Change in Fed Funds Rate ECRI Leading Eco. Indicator
150.0 2.00
140.0 1.70
130.0 1.40
120.0 1.10
110.0 0.80
100.0 0.50
90.0 0.20
80.0 -0.10
70.0 -0.40
60.0 -0.70
50.0 -1.00
89

91

93

95

97

99

01

03

05

07

09
19

19

19

19

19

19

20

20

20

20

20
The Fed funds rate will stay low for months or quarters until the leading
indicators are materially higher than the 2007 peak.
Page 45 of 58
“MV=PQ” . . . Money Supply x Velocity = Price x Real Output
FUEL FOR THE FIRE
M2 SINCE 2000, RAW MATERIAL FOR GDP GROWTH

9,000 $8,654
$8,473

8,000
$7,522 $7,769
BILLIONS OF $

7,000 $6,697
$6,055
6,000
$4,972
5,000

4,000
9

9
-9

-0

-0

-0

-0

-0

-0

-0

-0

-0

-0
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

D
Source: St Louis Federal Reserve
M2 = M1 + money market accounts and other

Plenty of “M”, the money supply, as represented by M2, is at a

record high level in dollar terms and the highest in terms of % of
nominal GDP in over 20 years.

Page 46 of 58
 CHANGE M2 VELOCITY vs CHANGE IN NOMINAL GDP
1971 to Present

4 per. Mov. Avg. (% Change Nominal GDP Y-O-Y)

15 2.20
Nominal GDP Y-O-Y % Change

13 2.10
11 2.00

Nominal GDP / M2
9 1.90
7 1.80
5 1.70
3 1.60
1 1.50
(1) 1.40
(3) 1.30
(5) 1.20
72

75

78

81

84

87

90

93

96

99

02

05

08
p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-
Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se
Source: Bloomberg, Federal Reserve

Not so much “V”, the velocity of money has returned to levels last seen in
the 80‟s. Velocity is beginning to turn up – a precursor to sustained
GDP growth.
Page 47 of 58
 CHANGE M2 vs CHANGE IN CORPORATE PROFITS
(All Corporate Profits per NIPA)
NIPA Corp. Profit Y-O-Y % Change 1971 to Present

50% -6.0%

Y-O-Y % Change M2 - Inverted

Slowing M2 growth consistent
42%
with rising profit growth. -2.0%
34%
26%
2.0%
18%
10% 6.0%
2%
10.0%
-6%
-14%
14.0%
-22%
-30% 18.0%
2

8
7

0
p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-

p-
Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se

Se
Source: Federal Reserve, BEA - National Income and Products Accounts

Leading to more “Q”. When the trailing 12 month change in M2 has

been 5% or lower, annual corporate profits have grown in 98% of the
cases since 1971 by an average of 14%.

Page 48 of 58
INVESTOR’S YIELD STARVATION = BORROWERS INTEREST BARGAIN

Comparative Interest Rates

Fed Funds Rate 3-Month CD rates
10 Yr Treas rate BAA Corp Bonds
30 Yr Conventional Mortg
10.00
9.00
8.00
Annual % Rate

7.00
6.00 5.66
5.00
4.00 4.35
3.00
2.48
2.00
1.00 0.28
- 0.19
00

01

02

03

04

05

06

07

08

09

10
20

20

20

20

20

20

20

20

20

20

20
Record low interest rates: driving investors to take uncompensated risk,
allowing borrowers to lower costs and extend maturities.
Page 49 of 58
Low mortgage rates drive more refi activity => liberate more
homeowner disposable income.
Page 50 of 58
WHAT ABOUT THE GROWTH IN DEBT?
The growth in Federal borrowing is the single biggest risk factor to the
economy and my market outlook. The problem is shared by most of the
OECD countries. The political realities are unfolding in real time. We may
have finally reached a time of reckoning . . . and this is good. Chart
courtesy of Yardeni.Com.

Page 51 of 58
We currently have the liquidity and productivity to resolve the debt growth
issue.
Public U.S. Govt Debt vs. Money of Zero Maturity
(net of T-Bills)
1980 to Present
MZM / Public Govt Debt: Ex T-Bills MZM - Ex T-Bills
Publicly Held Debt -Ex T-Bills Median MZM % of Public Govt Debt
10,000
320.0%
$7,754
8,000 280.0%
$ Billions

115.9% $6,692 240.0%

6,000 200.0%
129.8% 160.0%
4,000
120.0%
80.0%
2,000
40.0%
- 0.0%
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
Sources: St. Louis Fed, Dallas Fed, TreasuryDirect

A resolution other than raising taxes will be extremely bullish.

Page 52 of 58
THE MODEL SAYS STOCKS ARE INCREDIBLY CHEAP

LTM P/E Ratio S&P 500

1926 to Present
Median P/E Ratio 1926 Median P/E Ratio Since 1982
4 Year Moving Average
35
29.44
30

25
21.61
20 18.31
17.22
15
14.47 14.61
10 11.51
15.44
5
6.97 6.68
5.90
0
26

31

36

41

46

51

56

61

66

71

76

81

86

91

96

01

06
-

-
ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec

ec
D

D
The lowest P/E ratio in nearly 20 years.

Page 53 of 58
The market has never been over 60% undervalued as it is today. It
has only been more than 40% undervalued 5 times since 1970 and has
been up 80% of the time 12 months later.
S&P 500 Actual Price vs. Cap Rate Value
% Over Valued % Under Valued
S&P 500 Actual Cap Rate Fair Value
3,600 280%
3,139 245%
3,000
S&P 500

1,212 210%
2,400
175%
1,800 140%

% Over / Under Valued

1,200 105%
72%
600 70%
35%
-
0%
(600) -35%
-43.9%
-59.1%
(1,200) -61.4% -70%

Page 54 of 58
THERE IS CHANGE IN THE WIND . . . GOOD FOR STOCKS IN 2011
The Republicans took control in the House – similar to 1994. Following the
wholesale change in the control of Congress in favor of the Republicans in
1994 – The S&P 500 rose 34% and the NASDAQ rose 40% in the
following year. The economy was in a similar stage of recovery and
earnings were also at a similar point of growth as is the case today.
History says that gridlock in Washington is good for the stock market.
It has at least been coincidental with, if not contributory to, strong equity
market performance. The following chart comes courtesy of the Carpe Diem
blog of Mark Perry and an article by Eric Singer of the Congressional Effect
Fund.

Page 55 of 58
ARE WE POSSIBLY ON THE CUSP OF A “GOLDEN AGE”?
Innovation is the central issue in economic prosperity.
Michael Porter, Harvard Business School

A Modern Day "Cambrian Explosion": U.S. Patent Applications

1883 to 2008
500,000 456,321
450,000
400,000
350,000 Mid 90's - The 342,441
Internet Takes Off
300,000
250,000 228,142
200,000 Mid 80's - Personal
150,000 Computing Takes Off
111,284
100,000
104,079
50,000
44,774
0
83

93

03

13

23

33

43

53

63

73

83

93

03
18

18

19

19

19

19

19

19

19

19

19

19

20
Source: WIPO Statistics Database, December 2009

Page 56 of 58
Extended periods of economic growth have resulted from mainstream
implementation of communication innovations facilitating trade,
intermediation of new technology discoveries and accelerated growth in
productivity . . . We are now in such a period!

Page 57 of 58
CHECKING THE BOXES

We are in an early phase of sustainable economic and market recovery.

The leading indicators are pointing up.
Jobs are recovering.

The consumer is better off.

Residential housing is starting to recover.

Profits and business investments are recovering.
The banks are able to lend.

Interest rates and monetary data are signaling improvement.

We are not drowning in debt.

Stocks are incredibly cheap.

Political change is good for stocks.

We are in a golden age of innovation.

Page 58 of 58