Life Goes On in Serengeti 2010 update 11-10-2010

8/7/2019 Life Goes On in Serengeti 2010 update 11-10-2010

http://slidepdf.com/reader/full/life-goes-on-in-serengeti-2010-update-11-10-2010 1/58

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LIFE GOES ON IN THE SERENGETI

U.S. Market & Economic Chart Stack

Jeb B. Terry, PresidentAberdeen Investment Management, LLC

As of November 10, 2010

[email protected] www.aberdeeninvestment.com

Caution: It’s a risky world we live in. My opinions are based on information believed to be reliable buthey, 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

mailto:[email protected]


http://www.aberdeeninvestment.com/






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LIFE GOES ON . . .

LAST YEAR – IT WAS “RUN FOR YOUR LIVES”!

THIS YEAR – THE HERD IS BACK TO WHAT COMES NATURAL

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.

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 .



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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.



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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



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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



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EQUITIES STILL IN EARLY RECOVERY

So . . . capital always seeks a return, just as the wildebeests will alwaysmigrate around the Serengeti, some will be lion food but most willsucceed, procreate and sustain the herd.

S&P 500 LONG TERM TREND STILL UPPRICE HISTORY: 1926 TO PRESENT

[Log Scale]

265

38

152

1,000

538

2,725

12,928

1

1,000

1 9 2 6

1 9 3 1

1 9 3 6

1 9 4 1

1 9 4 6

1 9 5 1

1 9 5 6

1 9 6 1

1 9 6 6

1 9 7 1

1 9 7 6

1 9 8 1

1 9 8 6

1 9 9 1

1 9 9 6

2 0 0 1 2 0

0 6

P R I C E I N D E X

1 9 2 6 = 1 0 0

9,959

The S&P 500 remains wellabove its long term trend.



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REGRESSION TO THE MEAN

The statistical likelihood is that the next 10 years should be muchbetter.

Gains are far more frequent than losses. The mean 10 year return since 1926is 107%. The mean 1 year return since 1926 is 8%.

S&P 500PRICE HISTORY: 1926 TO PRESENT

29%

-58%

313%

87%

-25%

34%57%

272%

369%

88%

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

1 9 2 6

1 9 3 0

1 9 3 4

1 9 3 8

1 9 4 2

1 9 4 6

1 9 5 0

1 9 5 4

1 9 5 8

1 9 6 2

1 9 6 6

1 9 7 0

1 9 7 4

1 9 7 8

1 9 8 2

1 9 8 6

1 9 9 0

1 9 9 4

1 9 9 8

2 0 0 2

2 0 0 6

2 0 1 0

10 Year % Change 10 year % Change - Linear Regression

-11%



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ABUNDANCE OF FEAR, ABSENCE OF GREED=> GOOD TIME TO INVEST

Investors are working their way through the psychological impact of the2008/2009 panic in the markets.

The implication: We are at a point of “maximum financial opportunity”.

WE ARE HERE



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U.S. Nominal GDP vs. Money of Zero Maturity1969 to Present

56.6%

38.7%31.6%

39.8%41.4%

-$7,500-$5,000

-$2,500

$0

$2,500

$5,000

$7,500$10,000

$12,500

$15,000

D e c - 6

9

D e c - 7

1

D e c - 7

3

D e c - 7

5

D e c - 7

7

D e c - 7

9

D e c - 8

1

D e c - 8

3

D e c - 8

5

D e c - 8

7

D e c - 8

9

D e c - 9

1

D e c - 9

3

D e c - 9

5

D e c - 9

7

D e c - 9

9

D e c - 0

1

D e c - 0

3

D e c - 0

5

D e c - 0

7

D e c - 0

9

$ B i l l i o

n s

0.0%

25.0%

50.0%

75.0%

100.0%

125.0%

150.0%

MZM % of GDP MZM Nominal GDP Median MZM % of GDP

$9,537

$14,800

Sources: St. Louis Fed, Dallas Fed

64.4%

The public‟s willingness to hold unprecedented levels of “money of zeromaturity” not to mention “money of zero yield” is a dramatic expression ofthe complete absence of greed in the market today.



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

Equity vs. Bond Mutual Fund Net New Cash Flow

$(15)$(11)$(28)

$(238)

$309

$215

$(65) $(50)

$140

$375

$(300)

$(200)

$(100)

$-

$100

$200

$300

$400

$500

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

$ B i l l i o

n s

Equity Bond

Unprecedentedmove into retail

bond funds

Unprecedentedmove into retail

equity funds

Unprecedentedmove out of retail

equity funds

There has NEVER been as much money paid into any type of mutualfund in any single year as went into bond funds last year!



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

MONTHLY NYSE MARGIN DEBT

2000 TO PRESENT

$278,530

$130,210

$173,300

$381,370

$235,748

$-

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

J a n - 0 0

J a n - 0 1

J a n - 0 2

J a n - 0 3

J a n - 0 4

J a n - 0 5

J a n - 0 6

J a n - 0 7

J a n - 0 8

J a n - 0 9

J a n - 1 0

$ M i l l i o n s

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 resembleswhere we were in 2004, the early phase of a three year bull market.



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THE LEADING ECONOMIC INDICATORS REMAIN IN AN UPTREND

The weekly economic indicators published by the Economic Cycle ResearchInstitute are still signaling a recovery.

ECRI Weekly Leading Economic Indicators2000 to Present

120.4

105.5

115.3112.8

85

95

105

115

125

135

145

J a n - 0 0

J a n - 0 1

J a n - 0 2

J a n - 0 3

J a n - 0 4

J a n - 0 5

J a n - 0 6

J a n - 0 7

J a n - 0 8

J a n - 0 9

J a n - 1 0

-20%

-10%

0%

10%

20%

30%

40%

50%

6 Month % Change-Positive 6 Month % Change-Negative

Weekly Leading Eco Indicators (left scale) 6 Month % Change



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The drop in the economy was steeper and the recovery has been fasterand stronger.

Weekly Leading Economic Indicator Trend in Recovery

Weekly % Change in LEIBeginning of Recovery = 100

Economic Cycle Research Institute

90

100

110

120

130

W e e k 1

W e e k 1

7

W e e k 3

3

W e e k 4

9

W e e k 6

5

W e e k 8

1

W e e k 9

7

W e e k 1

1 3

W e e k 1

2 9

W e e k 1

4 5

W e e k 1

6 1

W e e k 1

7 7

W e e k 1

9 3

W e e k 2

0 9

W e e k 2

2 5

W e e k 2

4 1

W e e k 2

5 7

2009 Recession Recovery 2001 Recession Recovery

1991 Recession Recovery



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GDP GROWTH IS RETURNING – PRODUCTIVITY IS RISING

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

New Orders Have Led GDP GrowthYOY GDP Growth vs ISM Mfg New Order Index

-3%

-1%

0%

1%

3%

4%

6%

7%

8%

10%

11%

13%

14%

M a r - 8 2

M a r - 8 4

M a r - 8 6

M a r - 8 8

M a r - 9 0

M a r - 9 2

M a r - 9 4

M a r - 9 6

M a r - 9 8

M a r - 0 0

M a r - 0 2

M a r - 0 4

M a r - 0 6

M a r - 0 8

M a r - 1 0

Y e a r O v e r Y e a r

% C

h a n g e i n

N o m i n a l G D P

20

25

30

35

40

45

50

55

60

65

70

75

80 ISM

MfgNew

OrdersDifussion

Index50+=Expansion

Nominal GDPISM Mfg New Order Index - 4 quarter Average



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Spikes in productivity have also signaled rebounds in GDP growth.

Productivity Leads GDP Growth

Nominal GDP vs. GDP/Employed

Year Over Year % Change

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

C h a n g e i n N o m i n a l G D P

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%Chnag

einGDP/Person

Employed

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



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Ample unused capacity means no double dip, low inflation risk, moreproductivity growth and more profit expansion to come.

Source: First Trust



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JOBS ARE IMPROVING

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

(8,000)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

Y e a r O v e r Y e a r C h

a n g e - T h o u s a n d s

YOY Change in Persons Employed 1958 to PresentEstablishment vs. Household Survey

Household SurveyEstablishment Survey

Source: Bureau of Labor Statistics

819829



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Drop in the percentage of the population employed = excess laborcapacity => subdued wage inflation. Baby Boom Echo generation will behitting its peak labor force impact over the next 3-5 years.

% of Population Employed1980 to Present

42.6%

47.5%

46.3%

48.2%48.8%48.8%

47.23%

42%

43%

44%

45%

46%

47%

48%

49%

50%

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

P e r c e n t

Median % of Population Employed

12 Month Moving Avg. % of Pop. Employed

45.16%

Source: Bureau of Labor Statistics, Census Bureau



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

American Staffing Association

71

110

60

70

80

90

100

110

120

J u n - 0 6

O c t - 0 6

F e b - 0 7

J u n - 0 7

O c t - 0 7

F e b - 0 8

J u n - 0 8

O c t - 0 8

F e b - 0 9

J u n - 0 9

O c t - 0 9

F e b - 1 0

J u n - 1 0

I n d e x

V a l u e

J u n e 1 2 , 2 0 0 6 = 1 0 0

Staffing Index12 per. Mov. Avg. (Staffing Index)

6 per. Mov. Avg. (Staffing Index)

100



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A fly in the ointment . . . small business isn’t hiring . . . small businessis terrified of Obamacare and taxes.



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WHAT ABOUT THE CONSUMER? DEBT DOWN, SAVINGS UP

STILL HOARDING CASHM1 SINCE 1970

$1,208

$1,400

$381$204

$792

$1,175

$-

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

J a n - 7 0

M a y - 7 2

S e p - 7 4

J a n - 7 7

M a y - 7 9

S e p - 8 1

J a n - 8 4

M a y - 8 6

S e p - 8 8

J a n - 9 1

M a y - 9 3

S e p - 9 5

J a n - 9 8

M a y - 0 0

S e p - 0 2

J a n - 0 5

M a y - 0 7

S e p - 0 9

$ B i l l i o n s

Aug-10

Source: Federal Reserve, Not seasonally adjusted

9-11-2001Terrorist Attack

Sept/Oct 2008 Financial Melt Down $1,743

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

In addition to paying downdebt the consumer hasbeen accumulating cash.



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Personal Income vs Spending 1990 = 100

262

258

264262

90

120

150

180

210

240

270

300

D e c - 9 0

D e c - 9 2

D e c - 9 4

D e c - 9 6

D e c - 9 8

D e c - 0 0

D e c - 0 2

D e c - 0 4

D e c - 0 6

D e c - 0 8

Disposable Personal IncomePersonal consumption expenditures

Rebuilding Liquidity: Months of PCE Held as Cash,Savings Dep & Retail Money Market Funds

1980 to Present

9.4

8.5

11.1

10.3 10.3

8.0

8.4

8.7

9.1

9.4

9.8

10.1

10.5

10.8

11.2

11.5

D e c - 8

0

D e c - 8

2

D e c - 8

4

D e c - 8

6

D e c - 8

8

D e c - 9

0

D e c - 9

2

D e c - 9

4

D e c - 9

6

D e c - 9

8

D e c - 0

0

D e c - 0

2

D e c - 0

4

D e c - 0

6

D e c - 0

8

M o n t h s - M 2

M2 includes a broader set of financial assets held principally by households. M2 consists of M1plus: (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

10.03

Remarkable recovery inpersonal income andspending. Now at newhighs.

Over 10 months ofpersonal consumption

expenditure held incash and equivalents.



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Retirement Accounts & Cash vs. Nominal GDP

1985 to Present

$20,304

$3,123

$16,651

$4,319.3

$-

$5,000

$10,000

$15,000

$20,000

$25,000

D e c - 8

5

D e c - 8

7

D e c - 8

9

D e c - 9

1

D e c - 9

3

D e c - 9

5

D e c - 9

7

D e c - 9

9

D e c - 0

1

D e c - 0

3

D e c - 0

5

D e c - 0

7

D e c - 0

9

$ B i l l i o n s

Retirement & M1 & Retail Money Market Funds Nominal GDP

$18,675

$14,700

The naysayers are right to some extent . . . the U.S. consumer isn’ta saver . . . he’s an investor the likes of which has never been

seen in recorded history.

2009 saw the 2nd largest one year dollar gain in retirement account valuein history.



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We have more people in the prime ages for employment, consumptionand investment than ever in our history.

NUMBER OF PEOPLE REACHING AGE 49VERSUS AGE 18 AND 25

1954 TO 2018

2.0

2.32.5

2.8

3.0

3.3

3.5

3.8

4.04.3

4.5

4.8

5.0

1 9 5 4

1 9 5 8

1 9 6 2

1 9 6 6

1 9 7 0

1 9 7 4

1 9 7 8

1 9 8 2

1 9 8 6

1 9 9 0

1 9 9 4

1 9 9 8

2 0 0 2

2 0 0 6

2 0 1 0

2 0 1 4

2 0 1 8

M I L L I O N S O F P E O P L E

49 YR OLDS 18 YR OLDS 25 YR OLDS



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IS THE HOUSING BUST OVER? US Median Home Price

$181,900 $183,500

$179,300

$169,300

$213,600

$164,200

150,000

160,000

170,000

180,000

190,000

200,000

210,000

220,000

D e c - 0

7

F e b - 0

8

A p r - 0

8

J u n - 0

8

A u g - 0 8

O c t - 0

8

D e c - 0

8

F e b - 0

9

A p r - 0

9

J u n - 0

9

A u g - 0 9

O c t - 0

9

D e c - 0

9

F e b - 1

0

A p r - 1

0

J u n - 1

0

A u g - 1 0

Source: Natl. Assoc. ofRealtors www.realtor.org

Up 9% from the low.

US Housing Affordability Index

106.1

163.8

68.9

154.8

133.2

60.0

80.0

100.0

120.0

140.0

160.0

180.0

1 9 7 0

1 9 7 3

1 9 7 6

1 9 7 9

1 9 8 2

1 9 8 5

1 9 8 8

1 9 9 1

1 9 9 4

1 9 9 7

2 0 0 0

2 0 0 3

2 0 0 6

2 0 0 9

Source: Natl. Assoc. of Realtorswww.realtor.org

Best Since 1970

Median home prices appearto have found the floor.

Home affordability has neverbeen higher since the Boomersbegan to hit the home buying

population.



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Trailing 12 Month Housing Permits1959 to Present

854.2

982.5 934.7865.7

500

700

900

1,100

1,300

1,500

1,7001,900

2,100

2,300

2,500

J a n - 5

9

J a n - 6

2

J a n - 6

5

J a n - 6

8

J a n - 7

1

J a n - 7

4

J a n - 7

7

J a n - 8

0

J a n - 8

3

J a n - 8

6

J a n - 8

9

J a n - 9

2

J a n - 9

5

J a n - 9

8

J a n - 0

1

J a n - 0

4

J a n - 0

7

J a n - 1

0

P e r m i t s - T h o u s a

n d s

LTM Average Permits

607.6

Monthly Housing Permits vs New Jobs1959 to Present

0

50

100

150

200

250

J a n - 5

9

J a n - 6

2

J a n - 6

5

J a n - 6

8

J a n - 7

1

J a n - 7

4

J a n - 7

7

J a n - 8

0

J a n - 8

3

J a n - 8

6

J a n - 8

9

J a n - 9

2

J a n - 9

5

J a n - 9

8

J a n - 0

1

J a n - 0

4

J a n - 0

7

J a n - 1

0

P e r m i t s - T h o u s a n d s

(10,000)

(8,000)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

8,000

Persons-Thousands

12 per. Mov. Avg. (YOY Change in # Employed)

12 per. Mov. Avg. (Total Housing Permits)

Permits (and starts) won’t

fully recover until job growthis restored.

Housing permits haveapparently found a floor.



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Housing Start Surplus

2000 to Present

-920

594331

-460

555

2,0681,805

1,264

2,371

1,474

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

2,500

3,000

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

2 0 1 2

T h o u s a n d s S t a r t s

Excess <Deficit> Starts vs Median Annual Housing Starts

Cumulative Surplus Housing Stock Potential Housing Starts

1980 Median Starts

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



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So . . . Why should a tech investor like me care about housing data?

It means that TRILLIONS of dollars will no longer be pushed intoexcess housing stock and will therefore be looking for productive returns

elsewhere.

Mortgage Related Bonds Issued in U.S.as of September 2010

1,578.9

$3,071

$2,050

$1,340

$493

$684

$1,957

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

Y T D 2 0

1 0

B i l l i o n s

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



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A PROFITS & INVESTMENT LED RECOVERY

Corporate profits have recovered 2.5X faster than the average of thelast 3 recessions.

Corporate Profits on the Mend1972 to Present

(Seasonally Adj. Annual rates per NIPA)

$912.0

$1,655.1

$995.0

$765.0

$-

$250

$500

$750

$1,000

$1,250

$1,500

$1,750

$2,000

J u n - 7 2

J u n - 7 4

J u n - 7 6

J u n - 7 8

J u n - 8 0

J u n - 8 2

J u n - 8 4

J u n - 8 6

J u n - 8 8

J u n - 9 0

J u n - 9 2

J u n - 9 4

J u n - 9 6

J u n - 9 8

J u n - 0 0

J u n - 0 2

J u n - 0 4

J u n - 0 6

J u n - 0 8

J u n - 1 0

$ B i l l i o n s

Linear (Corp Profits -NIPA $ Billions SA Annual Rates)

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

$1,614.1



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Industrial production and earnings are in strong recovery mode. Thefollowing series of charts from Yardeni.com illustrate strong growth and tightcorrelation of earnings, industrial production, European growth and jobs.



of 58

The U.S. is not alone . . . Europe is also in recovery despite what you heardlast summer.



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Earnings and industrial production lead to jobs – earnings growth willslow but remain above 20% and strong enough to support job growth.



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

Real business

investment showingsigns of recovery.



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The Tech Pulse Index is a summary statistic that tracks the health of thetechnology sector. The “pulse” is rising faster than anytime since the90’s!

TECH PULSE INDEX1990 to Present

12 Month % Change

-18.5%

-31.8%

38.6%

-40%

-20%

0%

20%

40%

60%

D e c - 8

9

D e c - 9

1

D e c - 9

3

D e c - 9

5

D e c - 9

7

D e c - 9

9

D e c - 0

1

D e c - 0

3

D e c - 0

5

D e c - 0

7

D e c - 0

9

12 Month % Change-Nominal Dollar Terms12 per. Mov. Avg. (12 Month % Change-Nominal Dollar Terms)

BUBBLE

BUST

Source: Fed Reserve Bank of SF

20.40%

BOOM?



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

TECH PULSE INDEX VS. NASDAQ1980 to Present

12 Month % Change

19.37%14.09%

53.12%56.87%

-40.54%

-59.21%

85.78%86.05%

56.84%

43.89%

52.46%

-80%

-60%

-40%

-20%0%

20%

40%

60%

80%

100%

M a r -

8 0

M a r -

8 2

M a r -

8 4

M a r -

8 6

M a r -

8 8

M a r -

9 0

M a r -

9 2

M a r -

9 4

M a r -

9 6

M a r -

9 8

M a r -

0 0

M a r -

0 2

M a r -

0 4

M a r -

0 6

M a r -

0 8

M a r -

1 0

12 Month % Change-Nominal Dollar Terms12 Month % Change-NASDAQ

BOOM

BUST

Source: Fed Reserve Bank of SF

20.40%



of 58

WHAT ABOUT THE BANKS? GETTING BACK INTO LENDING MODE

LOAN BALANCES HAVE STOPPED FALLING

BANK C&I LOANS SINCE 1970

$869

$1,601

$1,096

$286$106

$607 $644

$-

$200

$400

$600

$800

$1,000

$1,200$1,400

$1,600

$1,800

J a n - 7

0

J a n - 7

2

J a n - 7

4

J a n - 7

6

J a n - 7

8

J a n - 8

0

J a n - 8

2

J a n - 8

4

J a n - 8

6

J a n - 8

8

J a n - 9

0

J a n - 9

2

J a n - 9

4

J a n - 9

6

J a n - 9

8

J a n - 0

0

J a n - 0

2

J a n - 0

4

J a n - 0

6

J a n - 0

8

J a n - 1

0

$ B i l l i o n s

Aug-10

Source: Federal Reserve, seasonally adjusted

Peak Dec 2000

Peak Oct 2008

$1,224

Bottom June 2004

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 reachingsustained growth.

Loan growth will pick up when borrowers need the cash for workingcapital and when competition for deposits drives up CD rates.



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A MONEY "DE-MULTIPLIER"M2 vs C&I Loans

SINCE 1970

$1,283

$5,431

$8,265

$598

$2,988

$-

$2,000

$4,000

$6,000

$8,000

$10,000

J a n - 7

0

M a y - 7

2

S e p - 7

4

J a n - 7

7

M a y - 7

9

S e p - 8

1

J a n - 8

4

M a y - 8

6

S e p - 8

8

J a n - 9

1

M a y - 9

3

S e p - 9

5

J a n - 9

8

M a y - 0

0

S e p - 0

2

J a n - 0

5

M a y - 0

7

S e p - 0

9

$ B i l l i o n s

C&I + Real Estate Loans M2

Source: Federal Reserve,

$8,654

$4,862

Resources and underwritingtalent will have to find a newsource of loan demand for asmuch as $500 billion per yearas real estate loans mature (ordefault ).

A report submitted toCongress marked the totalbad real estate loans at

~$150 billion. This numberwill likely grow . . . and thevultures can hardly wait!



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

A New Regime in Bank ReservesReduces Systemic RiskFree Reserves vs Loans

Since 1970

$5,431

$(1,000)

$-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

J a n - 7

0

J a n - 7

3

J a n - 7

6

J a n - 7

9

J a n - 8

2

J a n - 8

5

J a n - 8

8

J a n - 9

1

J a n - 9

4

J a n - 9

7

J a n - 0

0

J a n - 0

3

J a n - 0

6

J a n - 0

9

$ B i l l i o n s

C&I + Real Estate Loans Net Free Reserves

Source: Federal Reserve,

$928

$4,862

There will be casualties. Ihave heard estimates that

as many as 1,000 banks willbe forced to sell out or close

– it shouldn’t hurt thebanking system’s abilityto provide loans to the U.S

The FED has takenextraordinary steps tobolster reserves in the

system growing net freereserves from virtuallyzero to nearly $1 trillion.



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Since 1971, the NASDAQ has been up 85% of the time followingquarters 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 Curvevs % Change in NASDAQ

1980 to Present

56.956.8

85.8

52.539.936.9

(120)

(100)

(80)

(60)

(40)

(20)

-

2040

60

80

100

D e c - 8

2

J u n - 8

4

D e c - 8

5

J u n - 8

7

D e c - 8

8

J u n - 9

0

D e c - 9

1

J u n - 9

3

D e c - 9

4

J u n - 9

6

D e c - 9

7

J u n - 9

9

D e c - 0

0

J u n - 0

2

D e c - 0

3

J u n - 0

5

D e c - 0

6

J u n - 0

8

D e c - 0

9

N A S D A Q % C

h a n g e

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

YieldCurveHistogram

Yield Curve Histogram Y-O-Y % Change in NASDAQ Price

Source: Bloomberg, Federal Reserve



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A reduction in money market funds back to the 14.3% of GDP level ofJune 2005 would free up $680 billion from money market accounts.

THE MOUNTAIN OF MONEY:MONEY MARKET ACCOUNTS

Since 1980

$1,761

$2,214

$3,617

$-

$1,000

$2,000

$3,000

$4,000

M a r - 8 0

M a r - 8 2

M a r - 8 4

M a r - 8 6

M a r - 8 8

M a r - 9 0

M a r - 9 2

M a r - 9 4

M a r - 9 6

M a r - 9 8

M a r - 0 0

M a r - 0 2

M a r - 0 4

M a r - 0 6

M a r - 0 8

M a r - 1 0

$

$

i n

B i l l i o n s

Source: St. Louis Federal Reserve Bank

$2,805.3



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

REAL FED FUNDS RATE vs CHANGEIN MONEY MARKET ACCOUNTS

(4.0)

(3.0)

(2.0)

(1.0)

-1.0

2.0

3.0

4.0

5.0

6.0

D e c - 8 7

M a r - 8 9

J u n - 9 0

S e p - 9 1

D e c - 9 2

M a r - 9 4

J u n - 9 5

S e p - 9 6

D e c - 9 7

M a r - 9 9

J u n - 0 0

S e p - 0 1

D e c - 0 2

M a r - 0 4

J u n - 0 5

S e p - 0 6

D e c - 0 7

M a r - 0 9

J u n - 1 0

R e a

l F e

d F u

n d s

R a

t e %

(30)

(20)

(10)

-

10

20

30

40

50

60 Y-O-Y%

ChangeinMoneyMarket

Acc

ounts

REAL FED FUNDS RATE

Y-O-Y % Change in Money Markets Acct Balances




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

CHANGE IN NASDAQ vs CHANGEIN MONEY MARKET ACCOUNTS

11.60

56.8756.84 52.46

(80)

(62)

(44)

(26)

(8)

10

28

46

64

82

100

D e

c - 8 7

M a r -

8 9

J u n - 9

0

S e p - 9

1

D e

c - 9 2

M a r -

9 4

J u n - 9

5

S e p - 9

6

D e

c - 9 7

M a r -

9 9

J u n - 0

0

S e p - 0

1

D e

c - 0 2

M a r -

0 4

J u n - 0

5

S e p - 0

6

D e

c - 0 7

M a r -

0 9

J u n - 1

0

% C

h a n g

e i n N A S D A Q

(50)

(38)

(26)

(13)

(1)

1123

36

48

60

MMFundsY-O-Y%

Change(InvertedScale)

Y-O-Y % Change in NASDAQ Price

Y-O-Y % Change in Money Markets Acct Balances (Inverted)


Money market fund inflows slow or

contract-- Stock prices usually expand



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FED MONETARY POLICY – “W-I-T”= WHATEVER IT TAKES

ECRI Leading Indicators vs. Change in Fed Funds Rate

50.0

60.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

150.0

1 9 8 9

1 9 9 1

1 9 9 3

1 9 9 5

1 9 9 7

1 9 9 9

2 0 0 1

2 0 0 3

2 0 0 5

2 0 0 7

2 0 0 9

-1.00

-0.70

-0.40

-0.10

0.20

0.50

0.80

1.10

1.40

1.70

2.00

Chan e in Fed Funds Rate ECRI Leadin Eco. Indicator

The Fed‟s words and actions signal they will do whatever it takes to providestimulus and stability. Quantitative easing is the latest initiative.

The Fed funds rate will stay low for months or quarters until the leadingindicators are materially higher than the 2007 peak.



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

FUEL FOR THE FIREM2 SINCE 2000, RAW MATERIAL FOR GDP GROWTH

$6,055

$7,522

$6,697

$4,972

$7,769

$8,473

4,000

5,000

6,000

7,000

8,000

9,000

D e c

- 9 9

D e c

- 0 0

D e c

- 0 1

D e c

- 0 2

D e c

- 0 3

D e c

- 0 4

D e c

- 0 5

D e c

- 0 6

D e c

- 0 7

D e c

- 0 8

D e c

- 0 9

B I L L

I O N S O F $

Source: St Louis Federal ReserveM2 = M1 + money market accounts and other

$8,654

Plenty of “M”, the money supply, as represented by M2, is at arecord high level in dollar terms and the highest in terms of % ofnominal GDP in over 20 years.



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CHANGE M2 VELOCITY vs CHANGE IN NOMINAL GDP1971 to Present

(5)

(3)

(1)

1

3

5

7

9

11

13

15

S e p - 7 2

S e p - 7 5

S e p - 7 8

S e p - 8 1

S e p - 8 4

S e p - 8 7

S e p - 9 0

S e p - 9 3

S e p - 9 6

S e p - 9 9

S e p - 0 2

S e p - 0 5

S e p - 0 8

NominalG

DP/M2

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

2.20

N o m i n a l G D P

Y - O - Y % C

h a n g e

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


Not so much “V”, the velocity of money has returned to levels last seen inthe 80‟s. Velocity is beginning to turn up – a precursor to sustainedGDP growth.



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CHANGE M2 vs CHANGE IN CORPORATE PROFITS(All Corporate Profits per NIPA)

1971 to Present

-30%

-22%

-14%

-6%

2%

10%

18%

26%

34%

42%

50%

S e p

- 7 2

S e p

- 7 5

S e p

- 7 8

S e p

- 8 1

S e p

- 8 4

S e p

- 8 7

S e p

- 9 0

S e p

- 9 3

S e p

- 9 6

S e p

- 9 9

S e p

- 0 2

S e p

- 0 5

S e p

- 0 8

Y-O-Y%

Change

M2-Inverted

-6.0%

-2.0%

2.0%

6.0%

10.0%

14.0%

18.0% N I P A C o r p . P r

o f i t Y - O - Y % C

h a n g e

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

Slowing M2 growth consistent with rising profit growth.

Leading to more “Q”. When the trailing 12 month change in M2 hasbeen 5% or lower, annual corporate profits have grown in 98% of thecases since 1971 by an average of 14%.



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INVESTOR’S YIELD STARVATION = BORROWERS INTEREST BARGAIN

Record low interest rates: driving investors to take uncompensated risk,allowing borrowers to lower costs and extend maturities.

Comparative Interest Rates

0.190.28

2.48

5.66

4.35

-

1.00

2.00

3.00

4.00

5.006.00

7.00

8.00

9.00

10.00

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

A n n u a l % R

a t e

Fed Funds Rate 3-Month CD rates

10 Yr Treas rate BAA Corp Bonds

30 Yr Conventional Mortg



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Low mortgage rates drive more refi activity => liberate morehomeowner disposable income.



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WHAT ABOUT THE GROWTH IN DEBT?

The growth in Federal borrowing is the single biggest risk factor to theeconomy and my market outlook. The problem is shared by most of the

OECD countries. The political realities are unfolding in real time. We mayhave finally reached a time of reckoning . . . and this is good. Chartcourtesy of Yardeni.Com.



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We currently have the liquidity and productivity to resolve the debt growthissue.

A resolution other than raising taxes will be extremely bullish.

Public U.S. Govt Debt vs. Money of Zero Maturity

(net of T-Bills)1980 to Present

129.8%

-

2,000

4,000

6,000

8,000

10,000

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 9 9 8

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

$ B i l l i o n

s

0.0%

40.0%

80.0%

120.0%

160.0%

200.0%

240.0%

280.0%

320.0%

MZM / Public Govt Debt: Ex T-Bills MZM - Ex T-Bills

Publicly Held Debt -Ex T-Bills Median MZM % of Public Govt Debt

$7,754

$6,692

Sources: St. Louis Fed, Dallas Fed, TreasuryDirect

115.9%



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THE MODEL SAYS STOCKS ARE INCREDIBLY CHEAP

LTM P/E Ratio S&P 5001926 to Present

5.906.97 6.68

18.31

11.51

21.61

14.47

29.44

15.44

17.22

0

5

10

15

20

25

30

35

D e c - 2

6

D e c - 3

1

D e c - 3

6

D e c - 4

1

D e c - 4

6

D e c - 5

1

D e c - 5

6

D e c - 6

1

D e c - 6

6

D e c - 7

1

D e c - 7

6

D e c - 8

1

D e c - 8

6

D e c - 9

1

D e c - 9

6

D e c - 0

1

D e c - 0

6

Median P/E Ratio 1926 Median P/E Ratio Since 1982

4 Year Moving Average

14.61

The lowest P/E ratio in nearly 20 years.



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THERE IS CHANGE IN THE WIND . . . GOOD FOR STOCKS IN 2011

The Republicans took control in the House – similar to 1994. Following thewholesale change in the control of Congress in favor of the Republicans in1994 – The S&P 500 rose 34% and the NASDAQ rose 40% in thefollowing year. The economy was in a similar stage of recovery andearnings 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 equitymarket performance. The following chart comes courtesy of the Carpe Diem

blog of Mark Perry and an article by Eric Singer of the Congressional EffectFund.



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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

342,441

104,079

44,774

456,321

111,284

228,142

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

1 8 8 3

1 8 9 3

1 9 0 3

1 9 1 3

1 9 2 3

1 9 3 3

1 9 4 3

1 9 5 3

1 9 6 3

1 9 7 3

1 9 8 3

1 9 9 3

2 0 0 3

Source: WIPO Statistics Database, December 2009

Mid 90's - TheInternet Takes Off

Mid 80's - Personal

Computing Takes Off



P 58 f 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.

Life Goes On in Serengeti 2010 update 11-10-2010

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