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THE 'RISK ON' LEMMING STAMPEDE

Fed's Q2 and POMO Guarantees Stock Market Advance?

We are experiencing unprecedented moves in financial equity markets as a direct result of the US Federal
Reserve money printing operations. The Federal Reserve is no longer operating as the traditional "Lender
of Last Resort" but rather is now experimenting in untested waters as the "Buyer of First Resort".
Everything is being done by the US government to restore consumer confidence in an attempt to restart
the US economy, which even after trillions of government spending, lending and guarantees is at best
lethargic. Employment is no longer just a US problem as systemic growth and rebalancing issues face the
entire globe. Issues that are acute enough to now be seen to be igniting social unrest in many countries
other than just the EU.

Gordon T Long
2/6/2011

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THE 'RISK ON' LEMMING STAMPEDE
Fed's Q2 and POMO Guarantees Stock Market Advance?

FEBRUARY MARKET COMMENTARY .................................................................................................................................................... 4


COMMENTARY HIGHLIGHTS - WHAT YOU NEED TO GET OUT OF THIS MONTH'S REPORT ....................................................... 4
BEWARE OF LURKING BANK RUNS ........................................................................................................................................................... 5
FINANCIAL FRAGILITY .......................................................................................................................................................................................................... 7
STRENGTHENING & CONVERGING CORRELATIONS................................................................................................................................................... 9
NON FINANCIAL BUSINESS DEBT & MATURITY WALL ............................................................................................................................................... 11
TRIGGER POINTS ................................................................................................................................................................................................................ 12
1- Frightening Financial Headline News ....................................................................................................................................................................... 12
2- Securities Counterfeiting ............................................................................................................................................................................................ 15
3- Government Financial Grabs and Nationalization .................................................................................................................................................. 16
4- False Accounting ........................................................................................................................................................................................................ 17
EUROPE'S 2011 FINANCIAL PRESSURE POINTS ........................................................................................................................................................ 18
DUE FOR A SOVEREIGN DEBT CRISIS .......................................................................................................................................................................... 18

TIPPING POINTS.......................................................................................................................................................................................20
CHANGES OF SIGNIFICANCE THIS QUARTER ...................................................................................................................................... 20
WORLD ECONOMIC FORUM REPORT ............................................................................................................................................................................ 24
GLOBAL FINANCIAL STABILITY REPORT....................................................................................................................................................................... 27
I - SOVEREIGN DEBT - PIIGS & II - EU BANKING CRISIS..................................................................................................................... 29
III - RISK REVERSAL ..................................................................................................................................................................................... 33
NEW SHOCKS ....................................................................................................................................................................................................................... 33
POTENTIAL CHINESE HARD LANDING ........................................................................................................................................................................... 33
IV - STATE & LOCAL GOVERNMENT......................................................................................................................................................... 37
MUNI BOND OUTFLOWS - The Meredith Whitney Effect ............................................................................................................................................... 37

GLOBAL MACRO......................................................................................................................................................................................38
GLOBAL MARKET PERFORMANCE .......................................................................................................................................................... 38
MACRO TRENDS........................................................................................................................................................................................... 40
BEGGAR-THY-NEIGHBOR .......................................................................................................................................................................... 41
CURRENCY WARS............................................................................................................................................................................................................... 41
US$ ANALYSIS - Key Charts ........................................................................................................................................................................................ 41
PROTECTIONISM, TARIFFS & CAPITAL CONTROLS ................................................................................................................................................... 46
INCREASING GLOBAL INFLATION PRESSURES ................................................................................................................................... 48
FOOD PRICE PRESSURES ................................................................................................................................................................................................ 51
OIL PRICE PRESSURES ..................................................................................................................................................................................................... 52

US ECONOMY ...........................................................................................................................................................................................53
KEY MONTHLY ECONOMIC INDICATORS – HAVE A CLOSER LOOK AT WHAT THE MAINLINE MEDIA DOESN’T DISCUSS. ...................... 53
2011 US ECONOMIC IMPEDIMENTS......................................................................................................................................................... 54
PUBLIC POLICY MISCUES .......................................................................................................................................................................... 58
CONFIDENCE GAME 2011 - THE YEAR OF CATCH-22 JIM QUINN .................................................................................................................. 58
DEBT CEILING POLITICS.................................................................................................................................................................................................... 59
STILL MORE REAL ESTATE PROBLEMS LOOMING .............................................................................................................................. 64
RESIDENTIAL REAL ESTATE ............................................................................................................................................................................................ 66
COMMERCIAL REAL ESTATE............................................................................................................................................................................................ 71

MARKET ANALYTICS ..............................................................................................................................................................................73


HIGHLIGHTS - WHAT YOU NEED TO KNOW .................................................................................................................................................. 73
CURRENT MACRO EXPECTATIONS ........................................................................................................................................................ 73
BIG PICTURE ................................................................................................................................................................................................. 74
OUR APPROACH........................................................................................................................................................................................... 75
SHORT TERM – TECHNICAL ANALYSIS ......................................................................................................................................................... 76
Gann ........................................................................................................................................................................................................................................ 76

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Elliott Wave ............................................................................................................................................................................................................................. 77
Channels ................................................................................................................................................................................................................................. 78
Cycles - Bradley Model ......................................................................................................................................................................................................... 78
Sentiment ................................................................................................................................................................................................................................ 79
Investors Intelligence ...................................................................................................................................................................................................... 79
American Association of Independent Investors ......................................................................................................................................................... 80
National Association of Active Investment Managers (NAAIM) ................................................................................................................................. 81
Sum of Variant Perception Sell Signals ........................................................................................................................................................................ 81
Smart Money / Dumb Money Confidence .................................................................................................................................................................... 82
Options Speculation Index ............................................................................................................................................................................................. 82
Short Interest - Percentage of Float .............................................................................................................................................................................. 83
Oscillators & Breadth Indicators of Importance .................................................................................................................................................................. 85
Price Momentum Oscillator (PMO) ............................................................................................................................................................................... 85
NYSE Overbought / Oversold ........................................................................................................................................................................................ 86
OEX Open Interest (Puts/Calls) .................................................................................................................................................................................... 86
TRIN ................................................................................................................................................................................................................................. 87
McClellan Oscillator ........................................................................................................................................................................................................ 87
INTERMEDIATE TERM – RISK ANALYSIS .................................................................................................................................................... 88
Margin Levels ......................................................................................................................................................................................................................... 89
VIX / VXO Warnings .............................................................................................................................................................................................................. 91
37 Trading Days Without a Correction ................................................................................................................................................................................ 95
A Classic 'Tell-Tale' Divergence to Watch .......................................................................................................................................................................... 95
LONGER TERM - FUNDAMENTAL ANALYSIS ................................................................................................................................................. 97
Rule of 20 ................................................................................................................................................................................................................................ 98
3 Market Valuation Indicators Screaming Caution ............................................................................................................................................................. 98
Hazards Of Using Estimated Forward Operating Earnings ............................................................................................................................................ 100
Q Ratio .................................................................................................................................................................................................................................. 101
Value Line Arithmetic ........................................................................................................................................................................................................... 103
Shiller PE Ratio .................................................................................................................................................................................................................... 104
S&P Earnings Minus 10 Year treasury Yield .................................................................................................................................................................... 104

S&P 500 TARGETS ................................................................................................................................................................................. 105


Near Term Support .............................................................................................................................................................................................................. 105
Intermediate Term Top ........................................................................................................................................................................................................ 105
Time Frame .......................................................................................................................................................................................................................... 105
What to Watch Carefully ..................................................................................................................................................................................................... 107

CONCLUSION ......................................................................................................................................................................................... 109

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FEBRUARY MARKET COMMENTARY
COMMENTARY HIGHLIGHTS - WHAT YOU NEED TO GET OUT OF THIS MONTH'S REPORT

1. With the implementation of QE2 and POMO the US Federal Reserve is no longer considered the
"Lender of Last Resort" but rather is now the "Buyer of First Resort". "Extend & Pretend" has been
elevated to Systemic Bubble Blowing with the implementation of these 2 programs which specifically
target Fed buying to increase bond, equity and asset prices.

2. EU Sovereign Debt Contagion is accelerating in Europe and the potential for stealth bank runs from
nervous corporate CFO's and international Finance Committees .

3. Inflation is now emerging and causing problems most clearly in the area of food and energy pricing.

4. Global unrest is gaining momentum and our Tipping Points have been broadened to cover "Social
Unrest" and "Geo-Political Event Risk".

5. Global risk and stability concerns are once again surfacing and being outlined by the IMF, World Bank,
World Economic Forum and others. The causes of the 2008 financial crisis have yet to be addressed.

6. The US Residential Real Estate market has now rolled over and is showing signs of entering a further
corrective leg.

7. Market Analytic and Technical Analysis however indicates that the market still has more to run as we
finish this bear market counter rally by June 2011 with a classic ending diagonal chart pattern.

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Beware of Lurking EU Bank Runs
BEWARE OF LURKING BANK RUNS

This is a warning to prepare for potential stealth bank runs cascading from North
Africa and Ireland through to EU regional banking centers.

Stealth bank runs are the unrecognized and perilous serpent lurking presently
below the European financial surface. They prey on slower moving archaic bond
vigilantes and anyone else swimming in these dangerous uncharted waters.

Investors need to fully appreciate that a modern bank run looks and operates
differently than what is depicted in the movies and what we most likely expect to
occur!

For starters, it isn't the individual depositor lining up, it's now Corporate CFOs or
Treasurers at their terminal en masse!

Secondly, it isn't driven by local depositors; it is now driven internationally by


Corporate Finance committees!

Thirdly, there are no telltale line-ups at bank doors. It is stealth, which will
happen in an unexpected electronic 'flash crash' panic blur!

Today, a triggering event will initiate global 'key strokes' that will
move unprecedented amounts of money within hours.

The Council of Foreign Relations just released a surprising report entitled:


Sovereign Credibility and Bank Runs.

"In the midst of the financial crisis of 2008, governments helped to prevent bank
runs by guaranteeing bank debts. Yet as sovereign solvency itself becomes an
issue, such guarantees quickly lose their value. If Ireland provides a rule of
thumb, bank runs can be expected once sovereign credit default swap
yields pass 3%. The figure below shows that when Irish government CDS yields first passed 3% in early 2009, foreign
deposits fled the country. This happened again in late 2010. Now that Spanish CDS yields have broken the 3% threshold,
there is reason to be concerned about the stability of Spanish bank deposits as well."

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The Council's report conspicuously leaves out Portugal which the following European CDS spreads clearly identify as being
above their 3% threshold line along with Spain and long time banking problem Greece.

There is little doubt with all the coverage on the European PIIGS that there is financial fragility present in the EU and with
all investors having money invested in European banks. Now we must add the North Africa / Middle East event shock.

Egyptian CDS spreads have now doubled to over 400 bps This is well above the 300 bps threshold level. Is it any wonder
that Mubarak immediately shut down all Egyptian banks for fear of both domestic band international bank runs.

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Egypt Banks Risk Run as Week of Protests Hits Economy Bloomberg 01-31-11

ITALY - The Invisible Elephant

The Italy / Spain = > North Africa link is historically significant!

Italy has a cool 2 Trillion EUR in debt and has much worse debt statistics than Spain (we will discuss this below). Italy's
debt-to-GDP ratio is 118% (2009). Greece got in trouble at 116%. Italy's deficit is smaller and has a high savings ratio.
However, nobody focuses on that as Spain is in the limelight with a debt-to-GDP ratio under 60%. Should austerity
measures result in a nominal GDP contraction in Italy, its debt stats will worsen very rapidly.

Italy is the elephant in the room followed closely by Spain.

Consider carefully the following chart and remember that significant Italian & Spanish trade & loans
flow to North Africa.

FINANCIAL FRAGILITY

Before I specifically address the Iberian peninsula's current banking exposure we need to step back and remember
September 2008. It was then that the global banking system faced its first modern day global bank run. As un-nerved as
the financial markets were at that time with Lehman Bros, Bear Stearns and Fannie Mae, it was the 'breaking of the buck'
at a money market fund called The Reserve Fund that triggered the actual bank run.

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When the financial markets and specifically Chief Financial Officers (CFOs) discovered that their short term cash funds held
in money market funds could potentially return less than their face value, they immediately and en masse moved their
cash funds from money market funds to short term treasury bills. Literally trillions of money moved within one afternoon
that prompted the Fed to immediately react with money market guarantees above the FDIC $100,000 limit. Almost
immediately, Hank Paulson, the US Treasury Secretary and Ben Bernanke were forced onto Capitol Hill and into closed
door sessions to discuss the gravity of the situation. The outcome was an avalanche of Fed programs and the
government's TARP program.

The point we need to remember is that when we have financial anxieties we have financial fragility. Any event, or rumor,
or financial report, can act as a crystallizing catalyst to push the financial markets into immediate and panic action.

Consider the present situation in the US Muni Bond Market. Reports had been streaming endlessly of the seriousness of US
state, city and local budgets. CDS's had been hovering near the Council of Foreign Relations 3% threshold range for
troubled states, such as California, New York, New Jersey and Illinois, during 2010 as the following Bloomberg screen
ilustrates.

Then noted financial analyst Meredith Whitney appears on 60 Minutes' on a Sunday for a 12 minute interview clip and all
hell breaks loose in an anxious Muni Bond market. The following Barclays Capital chart shows the dramatic shift when
financial fragility is present.

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There is little doubt with all the coverage on the European PIIGS that there is financial fragility present in the EU and with
all investors having money invested in European banks.

STRENGTHENING & CONVERGING CORRELATIONS

The International Monetary Fund (IMF) recently released its January 2011 Global Financial Stability Report Update. Though
I am sure it was not bedtime reading for most investors and fund managers, I can assure you that at least one person on
any corporate investment committee charged with risk has read it. They no doubt would have been as alarmed as I was by
such a clear warning as the IMF was giving.

Interaction between Sovereign and Banking Sector Risks Has Intensified

Despite improvements in market conditions since the October 2010 GFSR, sovereign risks within the euro area
have on balance intensified and spilled over to more countries. Government bond spreads in some cases reached
highs that were significantly above the levels seen during the turmoil last May. Pressures on Ireland were
particularly severe and led to an EU-ECB-IMF program. Correlations between the average sovereign yields of
Greece and Ireland and the yields of Portugal have remained high, but correlations have increased sharply in
recent months with yields of Spain, and to a lesser extent, Italy, as the tensions spread.

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While still contained to the euro area, the adverse interaction between the sovereign and banking risks in a
number of countries has intensified, leading to disruptions in some funding markets. CDS spreads written on
financial institutions have increased the most in countries in which there has been the greatest sovereign stress -
and this relationship is more positive now than in 2008.

Smaller and more domestically-focused banks in some countries have found access to private wholesale funding
sources curtailed. Many banks that have retained access have faced higher costs and are only able to borrow at
very short maturities.

Several countries, as well as their main banks, face substantial financing needs in 2011 as bank and sovereign
Debt-to- GDP ratios have risen substantially in the last several years. The confluence of funding pressures
and continued banking sector vulnerabilities leaves financial systems fragile and highly vulnerable to
deterioration in market sentiment.

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NON FINANCIAL BUSINESS DEBT & MATURITY WALL

What clearly stands out in the European debt charts below is the relative size of private debt in the Iberian peninsula and
the short term maturity duration. A significant part of this is no doubt commercial real estate as a result of the
pronounced real estate bubble experienced in both countries.

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It takes cash to service this debt and the requisite cash stream is imperiled and likely non-performing. Do you think any of
this is lost on corporate finance committees with cash held in any of these Iberian banks or Cajas?

TRIGGER POINTS

Nothing scares a Financial Officer more than:

1- Frightening Financial 'Headline News',


2- Securities Counterfeiting,
3-Government Financial Grabs & Nationalization or
4- False Accounting.

Let's examine each of these from an international finance committee's perspective so you can appreciate the 'buzz' around
the table as they overlay the unfolding North African events onto their major concerns with European Banking.

1- Frightening Financial Headline News

Is a bank run about to bring Europe to its knees? - Fortune

Some market watchers say yes, pointing ominously to the torrents of money pouring out of Ireland.

Irish bank deposits declined in November for the fourth straight month, the central bank said last week. Overseas
deposits fled the country at their fastest pace in more than a year.

The deposit flight compounds the stress on a financial system whose massive property-lending losses already
have driven the government to accept an unpopular bailout from the European Union and the International
Monetary Fund.

Worse yet, it shows that the solutions policymakers slapped together in the fall of 2008 helped in some cases to
create even bigger problems -- ones that are now coming due.

Unconditionally guaranteeing bank deposits is just such a policy, in a country where loan losses made the banks
insolvent, job loss left many taxpayers penniless and deposits now at least double annual economic output.

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And this time, given the unpopularity of bailouts and dysfunctional European politics, there is ample reason to
fear the banking mess won't so easily be swept aside.

"Facing facts like these, each morning when I wake up I have to wonder, 'Why is today not a good
day for a wholesale run on the Irish banking system?' And if there is a wholesale run on the Irish
banking system, then what stops the same scenario from cascading into Portugal, Greece, Italy, and
most importantly, Spain?"
asks Scott Minerd, chief investment officer at Guggenheim Partners.

That is very much the question being asked in bond markets, where the cost of borrowing surged in all the so-
called peripheral European countries in the second half of 2010. The yield on Irish 10-year government bonds, for
instance, surged to 9% at year-end from around 5% in August.

The high cost of market borrowing ties the hands of government officials who have promised to ride to the rescue
of the bubble-ridden banks. Ireland has already ponied up outlandish sums to keep the banks afloat. Officials
have said at every turn they believed they had the ability to stabilize the system, but stability has remained
beyond their reach.

Now, with the state locked out of the bond market and the banks losing depositors, who is going to lend in an
economy that already has shrunk drastically from its bubbly size of just a few years ago?

Bank runs "will seriously undermine the prosperity of this country for a generation. The first steps to stemming
the run would include "a big external aid package and steps by the Irish government."
Pimco's Mohammed El-Erian said in November.

The IMF, the EU and the Irish government committed to those steps this fall. But there is still no sign people in
Ireland or elsewhere believe the $113 billion bailout package will keep their money safe. Among many other
things, there has been a rush out of the euro for the Swiss franc, not to mention the ever-present embrace of
gold.

The flight from Irish banks has been most pronounced among foreigners, who presumably are less attached to
their bailed-out bankers and can easily find other banks that, at least for the moment, appear less apt to go out
of business.

Some 20 billion euros ($27 billion) of overseas deposits fled the country in November alone, according to the
Central Bank of Ireland. The level of foreign deposits has plunged 28% in the past year and is down 42% from its
bubbly peak.

But don't blame just the foreigners. Domestic deposits tumbled by 6.3 billion euros in November, in their
steepest decline since August 2009.

All told, the Irish banking system's deposit base has contracted by 15% over the past year -- which isn't making
it any easier for taxpayers to keep the deeply troubled banking sector afloat.

Meanwhile, the aid the Irish banks


took from the eurosystem more than
doubled over the past year, to 97
billion euros from 45 billion in
November 2009.

The flight of deposits from troubled


Irish banks is an unhappy irony
because Ireland was lauded in some
quarters in 2008 when it became the
first state to guarantee bank
deposits. That decision led to a
short-lived surge of funds into the
Irish banks -- not that the money
stuck around for long. Since the late
2008 peak, more than 100 billion
euros of overseas deposits have left
the Irish banking system.

When you consider that similar


trends could easily play out in the
other euro countries, you have the
recipe for a hangover-inducing New
Year that is likely, in the view of

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Minerd, to see the euro plunge anew against the dollar. He expects the euro to test its decadelong low against
the dollar of 85 cents before all is said and done, compared with a recent $1.33.

"As sovereign credit downgrades continue to flow in and deposits in Europe's weakened banking system flow out,
a broader crisis in Europe appears to be imminent in 2011," says Minerd.

This chart from SocGen makes very clear that in Europe, the perceived credit risk of various banks is tightly linked to the
credit risks of the countries in which they preside. That magnifies the risk significantly, and truly creates a notion of
systemic risk. In the US it's conceivable to have lots of defaults without a follow-on systemic crisis.

SPAIN - Pressure on Spanish Banks

Are credit markets predicting a bank run in Spain? (Pressure builds on Spain's banks Fortune)

The cost of insuring Spanish government debt climbed above 3% this month for the first time. Credit default
swaps referencing 5-year Spanish government bonds traded at 340 basis points Wednesday, according to CMA
data, meaning it costs $340,000 annually to protect $10 million of Spanish debt against default.

That spread has tripled over the past two years, as governments have started taking on the risks that were
initially shouldered by overstretched banks.

But more important, according to a post Wednesday by the Center of Geoeconomic Studies at the Council on
Foreign Relations, is a possible relationship between the level of the sovereign CDS spread and the effect on
foreign bank depositors.

The CFR blog post points out that deposits started flowing out of Irish banks in early 2009 when the nation's CDS
spread widened out beyond 3%. The spread quickly contracted and foreigners resumed putting their money in
the country's banks, as dodgy as they may have appeared, evidently banking on the strength of the government
deposit guarantee.

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But as the cost of the Irish bank bailout soared late last year, the Irish sovereign CDS spread surged past 3%
again, and foreign deposits resumed flowing out.

It is that flow that makes some investors think 2011 will be the year of the European bank run, starting in Ireland
– whose CDS spreads now exceed 6% -- and moving on to Portugal (5%) and then, perhaps, much bigger Spain.
Of course, it is early yet to say there will be a run on Spain's banks. While Spain and Ireland both had huge
property bubbles, Spain's biggest banks, Santander (STD) and Banco Bilbao (BBVA), have substantial
international businesses and thus appear to be in much better shape than their Irish counterparts, such as the
fraud-ridden Anglo Irish or the simply deflated Allied Irish (AIB).

The bad news is that there have been signs of a deposit pricing war that could add to the stress on the smaller
regional banks, which are seen as the weak link in the system. There are few indications the government is
moving aggressively to clean up the bad loans everyone knows are out there.

Even if all goes well, the Spanish banking system is going to need time to earn its way out of years of property-
lending misery. But if deposits start fleeing the country in earnest, the government will need to step in with
costly actions, such as mergers and recapitalizations and takeovers.

And as the Irish experience shows, a rising tab for taxpayer support of the banks isn't a recipe for making anyone
happy -- let alone for keeping money from heading for the exits.

2- Securities Counterfeiting

The international corporate finance committees and every CFO / Treasurer are reading that for the first time in the global
fiat currency system we have a European government printing money 'un-backed' in any way including the issue of
government debt instruments (even if those instruments are a worthless shame). This is nothing short of outright financial
counterfeiting.

Ireland Prints 25% of its GDP in German Euro‘s Barnes

The Irish Central Bank has crossed the Rubicon in European Union currency terms. They have printed up about
25% of their GDP in electronic credits, and stuffed those credits into their banks. These deposits, if you will, do
not have new debt issued behind them.

This is a form of hyperinflation if you will, at least in context that a Central Bank, with no actual printing press, or
a functioning bond market, has now electronically printed up new currency units for their banks without issuing
debt behind these actions.

While this has happened before in history, it has not happened in the Euro currency project officially before
today. This act is going to move the monetary policy of the union, to the individual capitals. The capacity to print
electronic credits, with out the creation of cash currency or debt, is a new wrinkle in the economic landscape.
The implications and ramifications will take a while to appear, but ―Mark‖ my words, Germany both as a people,
and as a political organization will notice this event. The German people now find themselves captured in a
currency where neighbors who are in political and financial stress, have the capacity to print up German Euros on
demand. This is Germany‘s worse nightmare as both a nation and a people. I dare say, you could not design a
more frightening prospect for the ―United German States‖, than to find their currency diluted on demand by
reckless neighbors.

In the coming weeks, and I say that because thing rarely happen quickly in life, Europe is going to have a
Sovereign crisis of epic size. They will have to decide what happens next, and do so rather quickly.

EU politicians have known about Ireland‘s decision to print currency for weeks now. They have had time to
consider their response to Ireland‘s dilution of the Euro. I do not expect an initial reaction in the currency
markets, as this kind of event takes time to be absorbed by all stakeholders in the Euro.

The Celtic Tiger has made their move and resorted to naked currency printing, to support its banks. The next
move belongs to Europe and it‘s going to be interesting to see how this plays out in the public arena‘s. We know
who is first, what CB will be second?

Irish lenders besiege central bank for emergency loans Pritchard

The latest data shows that Anglo Irish Bank and other lenders had borrowed €51bn (£43bn) from the Irish
central bank by the end of December, under an obscure progamme listed in the balance sheet as "other assets".

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This comes on top of €132bn in loans from the ECB itself, the figure normally tracked by analysts and itself 24pc
of all ECB lending.

"This is a horror story: it shows the cataclysmic condition of the Irish banking system," said Tim Congdon from
International Monetary Research. "The banks have borrowed €183bn in total, or 110pc of Irish GDP. They have
burned through all their capital and a lot of their deposits as well. This is going to end up on the national debt".

The actions of the Irish central bank are authorized by Frankfurt, but fall into a grey area of monetary policy
since they appear to involve creation of money outside the normal control of the ECB's governing council.

The use of Ireland's emergency liquidity assistance program (ELA) raises further questions since the quality of
collateral is unacceptable for normal ECB operations. The volume of borrowing has begun to level off after a
surge in November.

3- Government Financial Grabs and Nationalization

Hungary, Poland, and three other nations take over citizens' pension money to make up government budget
shortfalls.

The Adam Smith Institute Blog European nations begin seizing private pensions Hungary, Poland, and three other
nations take over citizens' pension money to make up government budget shortfalls. Old women eat lunch in a
retirement home in Budapest Dec. 13, 2010. Hungarian lawmakers rolled back a 1997 pension reform, allowing
the government to effectively seize up to $14 billion in private pension assets to reduce the budget gap while
avoiding painful austerity measures. People‘s retirement savings are a convenient source of revenue for
governments that don‘t want to reduce spending or make privatizations. As most pension schemes in Europe are
organized by the state, European ministers of finance have a facilitated access to the savings accumulated there,
and it is only logical that they try to get a hold of this money for their own ends. In recent weeks I have noted
five such attempts: Three situations concern private personal savings; two others refer to national funds.

The most striking example is Hungary, where last month the government made the citizens an offer they could
not refuse. They could either remit their individual retirement savings to the state, or lose the right to the basic
state pension (but still have an obligation to pay contributions for it). In this extortionate way, the government
wants to gain control over $14bn of individual retirement savings.

The Bulgarian government has come up with a similar idea. $300m of private early retirement savings was
supposed to be transferred to the state pension scheme. The government gave way after trade unions protested
and finally only about 20% of the original plans were implemented.

A slightly less drastic situation is developing in Poland. The government wants to transfer of 1/3 of future
contributions from individual retirement accounts to the state-run social security system. Since this system does
not back its liabilities with stocks or even bonds, the money taken away from the savers will go directly to the
state treasury and savers will lose about $2.3bn a year. The Polish government is more generous than the
Hungarian one, but only because it wants to seize just 1/3 of the future savings and also allows the citizens to
keep the money accumulated so far.

The fourth example is Ireland. In 2001, the National Pension Reserve Fund was brought into existence for the
purpose of supporting pensions of the Irish people in the years 2025-2050. The scheme was also supposed to
provide for the pensions of some public sector employees (mainly university staff). However, in March 2009, the
Irish government earmarked €4bn from this fund for rescuing banks. In November 2010, the remaining savings
of €2.5bn was seized to support the bailout of the rest of the country.

The final example is France. In November, the French parliament decided to earmark €33bn from the national
reserve pension fund FRR to reduce the short-term pension scheme deficit. In this way, the retirement savings
intended for the years 2020-2040 will be used earlier, that is in the years 2011-2024, and the government will
spend the saved up resources on other purposes.

It looks like although the governments are able to enforce general participation in pension schemes, they do not
seem to be the best guardians of the money accumulated there.
The table below is a summary of the discussed fiscal-retirement situations (source):
*These figures do not include the costs of higher taxes, price inflation and low interest rates, which additionally
devaluate retirement savings.

Partial Nationalization of Cajas Savings Banks (Spain plans partial nationalization of savings banks)

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Estimates of the cost to recapitalize the banks range from 17 billion to 120 billion euros with consensus falling in the 25
billion to 50 billion area, though Economy Minister Elena Salgado says it will be much lower.

- Spain plans a partial state takeover of its weakest savings banks as it seeks to reassure investors a rescue will
not weigh on its deficit.

- The government would force debt-laden regional savings banks to become conventional banks and seek stock
market listings to persuade skittish investors that they are good investments.

- The state-backed bank restructuring fund (FROB) would then take stakes in the banks -- known as cajas -- that
fail to attract private investment, the source said. Up to now the FROB has functioned as a lender of last resort to
the cajas.

- Deputy Prime Minister Alfredo Perez Rubalcaba told reporters a new savings bank plan was coming soon and
could include new laws, implying a reform of the FROB.

- High levels of bad property loans at the cajas are seen as a major risk for Spain.

- The Bank of Spain forced the cajas last year into a round of mergers, reducing their number to 17 from 45. Five
of them failed Europe-wide stress tests on banks last year.

- They must reveal by January 31 more details about their bad loans and property holdings. Only two cajas have
reported so far, but once all the reports are in, the Bank of Spain will be able to give a clear idea of the total
recapitalization needs.

- A bank recapitalization worth 50 billion euros would amount to about 5 percent of Spanish gross
domestic product, which could endanger the government's goal of cutting the budget deficit to 6
percent of GDP this year.

- The FROB would have to raise debt on the market to purchase the bank stakes. In theory, the books would be
balanced by the stakes in the savings banks to avoid a deficit impact, although the risk is those stakes dwindle in
value.Taking stakes in the banks will increase the government's debt needs, said Josep Soler, general director of
Financial Studies Institute. "We still don't know ... how much the cajas are going to need," he said. The FROB
would invest in the cajas at market rates subject to EU anti-trust approval, a government source told Reuters.

- While some of the biggest cajas are seen as attractive, investors have shied away from smaller ones, notorious
for being used by local politicians to fund pet projects from casinos to airports.

- The cajas plan a March trip to Asia, including China, following similar road shows in Europe and the United
States.

4- False Accounting

What is obvious to any CFO / Treasurer following the banking situation in Europe is that the European Bank Stress tests
were at best a sham and possibly even bordering on outright market manipulation by the powers to be. They are not
convinced.

The EU 'Extend & Pretend' program of hiding massive toxic debts, the avoidance of 'market-to market' real estate
accounting valuations to reflect (even approximate) acceptable LTV ratios, extensive off balance sheet Structured
Investment Vehicle (SIV) bank debt obligations still in place and extreme bank leverage ratios relative to the rest of the
world, leaves most financial professionals nervous. Very nervous.

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EUROPE'S 2011 FINANCIAL PRESSURE POINTS - Financial Times

DUE FOR A SOVEREIGN DEBT CRISIS

We Really Are Due For A Sovereign Debt Crisis Right About Now Clusterstock

Sovereign debt crisis are actually pretty common so there's nothing particularly abnormal about the current
situation in Europe, according to Rabobank.

Their research shows that sovereign defaults go all the way back to the fourth century B.C. It's only been
recently that everyone has forgotten and dismissed the threat of sovereign default.

From Rabobank:

In fact, if anyone would speak about it a few years ago, their economic understanding, and even possibly their
sanity, would be questioned by all. Sovereign debt crisis was a thing of the past, or so the argument went. And if
it did occur, it would most probably be in a ‗third world‘ country. The simple reason was that industrialized
countries had ‗graduated‘ from periodic bouts of government insolvency given that they did not opt for a default
since the 1960s.

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The bank's exhibit, a chart from the economists Reinhart and Rogoff, showing sovereign default is in no way
abnormal. Notable, the absence of "advanced economy" default since the 1960s. The eurozone crisis could be
about to end that.

“You will not know about, nor see these stealth bank runs until it is far too late to react”
The movement of money is hidden electronically and reported long after the fact.

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TIPPING POINTS

CHANGES OF SIGNIFICANCE THIS QUARTER: (See page #21-22 for details)

INCREASES IS WAS CHANGE

1) Oil Price Pressures 14 30 +16


2) China Bubble 9 22 +13
3) Food Price Pressures 5 15 +10
4) Rising Inflation Pressures &
Interest Rate Pressures 6 14 + 8
5) Geo-Political Event Risk New
6) Social Unrest New

DECREASES

1) North & Southern Korea 30 12 -18


2) Financial Crisis Programs
Expiration Impact 34 24 -10

We need to carefully watch:

1) The increasing & broadening potential for Global Contagion.


2) How and if the Central Banks actually do unwind their crisis ‗triage‘ programs or are they permanent?
3) Government public policy initiatives.

These events will allow us to determine if our roadmap is still valid or if we are going to see, and even sooner,
possibly poorer financial outcomes.

The public will soon wake up to the magnitude of money printing that is going on to support the economic recovery
fallacy. When the public does become aware, ―Money Velocity‖ will accelerate. When this happens, the likelihood is
that the markets will dramatically reverse, not because economic conditions are improving, but rather because of a
depreciating US dollar. We are truly exposed to the potential of a ―Minsky Melt-Up‖ or more correctly from an
Austrian perspective, a Von Mises ―Crack-up Boom‖.

The risks are presently towards a SHORT TERM worsening downside. The Intermediate Term calls for higher highs
into June 2011.

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IS WAS Diff.
SOVEREIGN DEBT - PIIGS Insolvency and Inability to stimulate 1 1 Same
economies
EU BANKING CRISIS Bank Ratios of 50:1 and toxic debt on 2 2 Same
and off the balance sheet
RISK REVERSAL Historic level of financial market 3 5 +2
participation and dependency (i.e.
pension entitlements)
US STATE & LOCAL GOVERNMENT Unprecedented budget shortfalls & 4 4 Same
funding problems
FOOD PRICE PRESSURES Production shortages, distribution 5 15 +10
break-downs with growing Asian
demand
RISING INFLATION PRESSURES & Reversal in Interest rate and impact on 6 14 +8
INTEREST RATES government financing budgets
SOCIAL UNREST Public rallies, protests and rioting 7 NEW
against the government.
CHRONIC UNEMPLOYMENT Historic Unemployment rates in G7 8 9 +1
CHINA BUBBLE Real Estate & speculative bubbles 9 22 +13

GEO-POLITICAL EVENT A sovereign country overthrow, 10 NEW


rebellion or insurrection
RESIDENTIAL REAL ESTATE – PHASE II Shadow Inventory, Strategic Defaults, 11 6 -5
Looming Option ARMS ‗python‘, LTV
levels.
COMMERCIAL REAL ESTATE Market Values are down 45 - 55% with 12 7 -5
little write downs as of yet being taken
by banks, insurance or financial
holders.
PUBLIC POLICY MISCUES Impact of Obamacare, Dodd-Frank Bill 13 13 Same
and others in reaction to present
environment.
OIL PRICE PRESSURES Shortages, Peak Oil & Asian Growth 14 30 +16
demand.
BOND BUBBLE Historically high Bond Prices 15 3 -12
PENSION – ENTITLEMENT CRISIS Unfunded Pension Liabilities - > $100T 16 11 -5
in US
CENTRAL & EASTERN EUROPE The Sub Price of Europe – Level of 17 8 -9
borrowing in non sovereign currency
(EU loans)

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US BANKING CRISIS II Deferred accounted write-downs for 18 10 -8
Real Estate, Commercial Real Estate &
HELOCS

CREDIT CONTRACTION II Bankruptcy & Mal-Investment Catalyst 19 18 -1


JAPAN DEBT DEFLATION SPIRAL Ability for Japan to continue to fund 20 18 -2
national debt with shifting demographic
patterns.
FINANCE & INSUR. BALANCE SHEET Accounting for Commercial Real Estate 21 17 -4
WRITE-OFFS market values, loan loss reserves
US STOCK MARKET VALUATIONS Over-Valuation and unrealistic earnings 22 16 -6
estimates.
GOVERNMENT BACKSTOP INSURANCE Fannie, Freddie, Ginnie, FHA, FDIC, 23 23 SAME
Pension Guarantee backstop funding.

SHRINKING REVENUE GROWTH RATE Slowing Corporate Top-Line revenue 24 27 +3


growth rates
GLOBAL OUTPUT GAP Global Overcapacity & Underutilization 25 29 +4
US DOLLAR WEAKNESS Domestic Inflationary Pressures 26 28 +2
US RESERVE CURRENCY Emergence of alternative solutions such 27 20 -7
as SDRs. Inflationary repatriation
impact
PUBLIC SENTIMENT & CONFIDENCE Growing social unrest and public rage 28 26 -2
SLOWING RETAIL & CONSUMER SALES Impact of slowing consumer sales and 29 25 -4
increasing savings rate on 70%
consumption US Economy
NORTH & SOUTH KOREA Geo-Political tensions - Escalating 30 12 -18
US FISCAL, TRADE AND ACCOUNT Inability of the US to finance 31 21 -10
IMBALANCES imbalances

CORPORATE BANKRUPTCIES Reverse Gearing & margin pressures 32 24 -8


TERRORIST EVENT Unknown black swan 33 35 +2
FINANCIAL CRISIS PROGRAMS Withdrawal of Financial Crisis Triage 34 24 -10
EXPIRATION Programs and interest rate
normalization
IRAN NUCLEAR THREAT Israeli attack on Iran - Middle East 35 33 -2
escalation
NATURAL PHYSICAL DISASTER Presently: Gulf Oil Spill Economic 36 31 -5
fallout and possible hurricane impact
PANDEMIC /EPIDEMIC Unknown black swan 37 32 -5

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WORLD ECONOMIC FORUM REPORT

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GLOBAL FINANCIAL STABILITY REPORT

The International Monetary Fund (IMF) recently released its January 2011 Global Financial Stability Report Update.
Though I am sure it was not bedtime reading for most investors and fund managers, I can assure you that at least
one person on any corporate investment committee charged with risk has read it. They no doubt would have been
as alarmed as I was by such a clear warning as the IMF was giving.

Interaction between Sovereign and Banking Sector Risks Has Intensified

Despite improvements in market conditions since the October 2010 GFSR, sovereign risks within the euro
area have on balance intensified and spilled over to more countries. Government bond spreads in some
cases reached highs that were significantly above the levels seen during the turmoil last May. Pressures
on Ireland were particularly severe and led to an EU-ECB-IMF program. Correlations between the average
sovereign yields of Greece and Ireland and the yields of Portugal have remained high, but correlations
have increased sharply in recent months with yields of Spain, and to a lesser extent, Italy, as the
tensions spread.

While still contained to the euro area, the adverse interaction between the sovereign and banking risks in
a number of countries has intensified, leading to disruptions in some funding markets. CDS spreads
written on financial institutions have increased the most in countries in which there has been the greatest
sovereign stress - and this relationship is more positive now than in 2008.

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Smaller and more domestically-focused banks in some countries have found access to private wholesale
funding sources curtailed. Many banks that have retained access have faced higher costs and are only able
to borrow at very short maturities.

Several countries, as well as their main banks, face substantial financing needs in 2011 as bank and
sovereign Debt-to- GDP ratios have risen substantially in the last several years. The confluence of
funding pressures and continued banking sector vulnerabilities leaves financial systems fragile
and highly vulnerable to deterioration in market sentiment.

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I - SOVEREIGN DEBT - PIIGS & II - EU BANKING CRISIS

The one - two punch is still the EU Sovereign Debt Crisis associated with the PIIGS and a pending EU Banking
Crisis.

Interactive Graphic: Europe’s financial contagion Washington Post

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Global systemic crisis: Second half of 2011 - European context and US catalyst - Explosion of the Western public
debt bubble LEAP 2020 01/04/11

The Western public debt crisis is growing very rapidly under the pressure of four increasingly strong limitations:

- the absence of economic recovery in the United States which strangles all public bodies (including the
federal state (10)) accustomed to an easy flow of debt and significant tax revenues in recent decades (11)

- the accelerated structural weakening of the United States in monetary, financial as well as diplomatic
(12) affairs which reduces their ability to attract world savings (13)

- the global drying up of sources of cheap finance, which precipitates the crisis of excessive debt in
Europe‘s peripheral countries (in Euroland like Greece, Ireland, Portugal, Spain, ... and the United
Kingdom as well (14)) and is starting to touch key countries (USA, Germany, Japan) (15) in a context of
very large European debt refinancing in 2011

- the transformation of Euroland into a new "sovereign" that gradually develops new rules for the
continent‘s public debts.

These four constraints generate varying phenomena and reactions in different regions / countries.

Overheating East to falter before the bankrupt West recovers Ambrose Evans-Pritchard

Year III of the Long Slump is when we confront the Primat der Politik in tooth and claw, the phase when states
become erratic, victims fight back, and dissident intellectuals start to inflict damage on failed orthodoxies. The dog
that hasn't barked yet is the jobless army in Spain, the 43pc of youths without work. Bark it will when the €420
dole extension expires in February

Policy levers in the US, Europe, and Japan remain set on uber-stimulus with the fiscal pedal pressed to the floor
and rates near zero everywhere, yet OECD industrial output has not regained the peaks of 2007-2008 by a wide
margin. Leading indicators are tipping over again. We are one shock away from a liquidity trap.

The East-West trade and capital imbalances that lay behind the Great Recession are as toxic as ever. Surplus
states are still exporting excess capacity with rigged currencies -- the yuan-dollar peg for China and, more subtly,
the D-Mark-Latin peg within EMU for Germany.

Dangerously high budget deficits of 6pc, 8pc, or 10pc of GDP in countries with dangerously high public debts near
100pc may have prevented an acute depression, but they have not prevented the weakest rebound since World
War Two, and they cannot continue, whatever the assurances of New Keynesians and pied pipers of debt.

Cyclical bulls may see the surge in 10-year US Treasuries -- and therefore mortgages rates -- as a sign that growth
is about to blast off: structural bears suspect it may be the first convulsive shudder of bond vigilantes dismayed at
the easy willingness of Washington to spend $1.4 trillion above revenues next year, with no credible plan to contain
the monster thereafter.

Can bond yields rise on "sovereign risk" even as core prices grind lower towards deflation? Yes, they can, and this
baleful possibility is not in the textbooks.

Ben Bernanke made a fatal error by launching QE2 too early, with an incoherent justification, by dribs and drabs
for fine-tuning purposes. The QE card cannot easily be played a third time. If he now tries to print money on a
nuclear scale to crush all resistance and hold down Treasury yields, he risks exhausting Chinese patience and
invites the wrath the Tea Party Congress.

Pudding bowl haircuts will set off the next wave of distress for Europe‘s banks as they try to refinance $1 trillion by
2012, in competition with hungry sovereigns. Gold may slip at first as casino funds cut leverage to meet margin
calls, before punching higher to €1300 an ounce as investors seek gold bars in a precautionary move. Talk of
capital controls will grow louder.

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The second half of 2011 will mark the point in time when all the world‘s financial operators will finally understand
that the West will not repay in full a significant portion of the loans advanced over the last two decades. For
LEAP/E2020 it is, in effect, around October 2011, due to the plunge of a large number of US cities and states into
an inextricable financial situation following the end of the federal funding of their deficits, whilst Europe will face a
very significant debt refinancing requirement (1), that this explosive situation will be fully revealed. Media
escalation of the European crisis regarding sovereign debt of Euroland‘s peripheral countries will have created the
favourable context for such an explosion, of which the US ―Muni‖ (2) market incidentally has just given a foretaste
in November 2010 (as our team anticipated last June in GEAB No. 46 ) with a mini-crash that saw all the year‘s
gains go up in smoke in a few days. This time this crash (including the failure of the monoline reinsurer Ambac (3))
took place discreetly (4) since the Anglo-Saxon media machine (5) succeeded in focusing world attention on a
further episode of the fantasy sitcom "The end of the Euro, or the financial remake of Swine fever" (6). Yet the
contemporaneous shocks in the United States and Europe make for a very disturbing set-up comparable, according
to our team, to the "Bear Stearn " crash which preceded Lehman Brothers‘ bankruptcy and the collapse of Wall
Street in September 2008 by eight months. But the GEAB readers know very well that major crashes rarely make
headlines in the media several months in advance, so false alarms are customary (7)!

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III - RISK REVERSAL

NEW SHOCKS

Global economy 'cannot cope with new shocks' Guardian 01/13/11

The report perceived three "clusters" of risks:

• The threat of a new economic crisis which could arise from the tension between the increasing power
and wealth of emerging economies and the high levels of debt in the west.

• An "illegal economy nexus" involving fragile states, illicit trade, organised crime and corruption. The
report said the value of illicit trade was an estimated $1.3tn (£830bn) in 2009.

• The "unsustainable pressures" on resources created by a rising population and growing prosperity, which
was expected to increase demand for food, water and energy by 30-50% in the next 20 years.

In addition, the report highlighted five risks to watch:

1- the possibility of "all-out cyber warfare";

2- the additional fiscal pressure from ageing populations;

3- high and volatile commodity prices;

4- a retrenchment from globalization; and

5- the acquisition of weapons of mass destruction by terrorist groups.

Robert Greenhill, managing director and chief business officer at the World Economic Forum, said: "Twentieth
century systems are failing to manage 21st century risks; we need new networked systems to identify and address
global risks before they become global crises,"

Daniel Hofmann, Zurich Financial's chief economist, said:

"Current fiscal policies are unsustainable in most industrialized economies. In the absence of far-reaching structural
corrections, there will be a high risk of sovereign defaults."

POTENTIAL CHINESE HARD LANDING

SocGen crafts strategy for China hard-landing Ambrose Evans-Pritchard 01/22/11

Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over
the next year, with major ramifications for the rest of the world.

Société Générale said China's overheating may reach 'peak frenzy' in mid-2011

- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over
coming months that will push commodity prices much higher, followed by a sudden reversal as China
slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said
China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9
trillion) or 50pc of GDP over the past two years.

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- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According
to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain
Bokobza, Glenn Maguire and Wei Yao.

- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe.
"The skew of risks is very much for an extended period of overheating, and therefore
uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit
10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and
risks a "pernicious wage-price spiral".

- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to
anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a
fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by
early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would
destabilize the global economy. It is not our central scenario, but if it happens: commodities won't like it;
Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset
allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a
mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).

- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in
December is meaningless because the regime has resorted to price controls on energy, water, food and
other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without
disclosure. She said inflation is running at 7.6pc on a six-month annualized basis, and the sheer force of
money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is
set to accelerate.

- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be
highly destabilizing for the world." Charles Dumas, Lombard's global strategist, said the Chinese and
emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-
go funds is wrong: they risk losing half their money like last time."

- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year
end".

- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use
of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a
70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and
might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and
energy equities will prosper under a soft-landing,

- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover
as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese
equities. It will be clear enough by June which of these two outcomes is baked in the pie.

Is Chinese Policy Getting Too Tight? BCAR

The latest reserve requirement ratio (RRR) increase has triggered fears that the Chinese authorities are about to
significantly accelerate policy tightening, which could lead to a sharp slowdown in domestic credit and consequently
overall economic growth.

While such a risk scenario should not be ruled out, the odds are low. Our China Investment Strategy service has
long held the view that the Chinese authorities will maintain a tightening bias, and will guide credit growth closer to
nominal GDP growth. This will be a multi-year process, and will be highly contingent on the global environment and
the domestic economic situation. The most recent RRR adjustment was reportedly due to a sharp increase in bank
lending during the first two weeks of the year. Thus, the move may have been more of a warning to banks rather
than a harbinger of a harsher policy stance. The authorities‘ top priority remains the inflationary impact of liquidity
overflow on asset prices due partly to an influx of global capital inflows, rather than a clampdown on business
activity. There appears to be a shift of preference in the authorities‘ liquidity control tools: The PBOC has been
increasingly in favor of RRR adjustments rather than central bank bond issuance. In fact, the net issuance of

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central bank notes in recent months has been negative. This means the central bank has in fact been injecting
liquidity into the system, which has partially offset the apparently aggressive increases in required reserve
deposits.

Ten Economic and Investment Themes for 2011 Mish 01/04/11

1. US Municipal Bankruptcies Head to Center Stage

Look for Detroit and at least one other city in Michigan to go bankrupt. Also look for increasing discussions
regarding bankruptcy from Los Angeles, Miami, Oakland, Houston, and San Diego. Those cities are
definitely bankrupt, they just have not admitted it yet. The first major city to go bankrupt will cause a
huge stir in the municipal bond market. Best to avoid Munis completely.

2. Sovereign Debt Crisis Hits Europe

The ECB and EU are hoping things return to normal and they can deal with things more calmly in 2013.
The markets will not wait. Expect a new Parliament in Ireland to want to renegotiate whatever horrendous
deal Prime Minister Brian Cowen agrees to. Portugal and Spain will need bailouts. The surprise play in
Europe will be Italy, a country not on anyone's front burner. Italy will come under intense credit market
pressure, and when it does the whole Eurozone comes unglued. Europe's banks are insolvent and ECB
president Jean-Claude Trichet will have a choice, haircuts or massive printing.

3. Cutbacks in US Cities and States

With Republican governors holding a majority of governorships, with Republicans holding a majority in the
House, and with a far more conservative Senate, there is going to be little enthusiasm for increasing aid to
states. There will be some aid to states of course, but nowhere near as much as needed to prevent
cutbacks. Expect to see a huge number of layoffs and/or cutbacks in services. Cutbacks in cities and
states will be a good thing, but that will counteract other gains in employment. The unemployment rate
will stay stubbornly high.

4. Public Unions Under Intense Attack

Public unions will face increasing hostility, not only in the US but also the Eurozone and UK. Look for
Congress to consider legislation to kill collective bargaining. If it passes, the president would veto it. The

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problem however will not go away. Cities and states in distress will increasingly outsource every contract
they can.

5. China Overheats, Multiple Rate Hikes Coming

China, everyone's favorite promised land, has a hard landing. China will grow at perhaps 5-6% but that is
nowhere near as much as China wants, or the world expects. Tightening in China will crack its property
bubble and more importantly pressure commodities. The longer China holds off in tightening, the harder
the landing.

6. Property Bubble Bursts Wide Open in Australia and Canada

Australia, having largely avoided the global recession runs out of luck this time around. Look for the
Australian economy to fall into outright recession. Look for Canada to slow dramatically as its property
bubble pops. The US property bubble is much further progressed, by years, than Australia, Canada, and
China. This matters immensely.

7. US Avoids Double Dip

The tax cut extensions and the payroll tax decrease will keep the US out of recession. However, growth
estimates are still too high. The tax cut extensions do nothing more than maintain the status quo while
the payroll tax deduction is just for a year. Most will use it to pay down bills. Look for GDP at 2.0-2.5%.
That is the stall rate.

8. Year That Something Matters

For the global equity markets, this will be the year that something matters. Certainly nothing mattered in
2010, and optimism for equities is at extreme levels. I have no targets other than a suggestion this is an
extremely poor time to invest in darn near anything.

9. Decoupling in Reverse

I do not think any countries decouple in 2011, including China. However, on a relative basis, the US could.
Europe is a basket case, China is overheating, Australia is headed for recession, the UK is going nowhere,
and 2.0-2.5% growth in the US just might look damn good compared to anything else. Bear in mind far
more than 2.0-2.5% US growth is priced in, but on a relative basis that is likely to smash the performance
of the Eurozone, Australia, and Canada. China may grow 5.0-6.0% but with 10% priced in, overweight
China, the emerging markets and the commodity producing countries is a serious mistake. Actually,
equities are a mistake in general and so are commodities. Finally, falling commodity prices would be US
dollar supportive and supportive of a decreasing US trade deficit as well, especially if grain prices stay
high while oil sinks. Should grains stay firm while other commodities sink, it would help boost US GDP.

10. US Dollar to Strengthen

Look for the US dollar to strengthen because of the net effect of all the above issues.

Relative Performance Examples

On a relative but not absolute basis I like the US. On a currency adjusted basis I especially like Japan.
Here is a hypothetical example: Should foreign equities drop 20% and the US dollar strengthen 10% the
loss to US investors would be 30%. Should Foreign investors buy US equities and face a loss of 20% and a
10% rise in the dollar, they would see a 10% loss. US investors of course would see the full 20% loss.
Japan looks attractive in nominal terms but strengthening of the dollar compared to the Yen could negate
some if not all of that. Equities in general, with the possible exception of Japan do not look attractive.

Miscellaneous Issues

The order in which the above themes play out could be important. If a muni crisis hits the US before a
sovereign crisis in the Eurozone and a slowdown in China, the dollar may not initially perform as expected.
Similarly, if the US strengthens more than expected in the first quarter while Europe and China stagnate,
another leg down in treasuries may be in store with the US dollar quickly blasting higher.

I have no firm conviction for gold, silver, or US treasuries other than gold is likely to hold its own and then

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some should the ECB decide to print its way out of this mess.

US treasuries are now in no-man's-land dependent on the order of things and the reactions of foreign
central banks as the crisis plays out. Seasonally, treasuries are generally weak until June (think tax
purposes). However, there are so many factors now, including Fed purchases, it is hard to estimate.

2010 was a lull in the global economic crisis. Don't expect 2011 to be the same. Something, indeed many
things, are likely to matter in 2011.

IV - STATE & LOCAL GOVERNMENT

MUNI BOND OUTFLOWS - The Meredith Whitney Effect

State Bankruptcy Option Is Sought, Quietly Path Is Sought for States to Escape Debt Burdens NY Times

Basically at the behest of Newt Gingrich, Senators and Congressmen in DC are looking for a new law that would
allow states to declare bankruptcy and restructure their debts including to (actually especially to) unionized public
workers.

If this doesn't frighten Muni-Bond holders then they are dead!

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GLOBAL MACRO

GLOBAL MARKET PERFORMANCE

Final 2010 Global Market Performance BeSpoke

To the right we highlight the 2010 returns (in


local currencies) for equity markets around the
world.

As shown, the average country saw its major


equity market index gain 15.33% in 2010.

Sri Lanka's stock market gained the most at


96.01%, while Bermuda declined the most at -
44.87%. Six other countries along with Sri
Lanka gained more than 50% in 2010 --
Bangladesh (82.79%), Estonia (72.62%),
Ukraine (70.20%), Peru (64.99%), Lithuania
(56.49%), and Argentina (51.83%).

Looking at just the G-7 countries, Germany did


the best at 16.06%, followed by Canada
(14.45%), the US (12.78%), and the UK (9%).

The three other G-7 countries -- France, Japan,


and Italy -- all declined last year.

Of the BRICs, Russia gained the most at


22.70%, followed by India (17.43%), Brazil
(1.04%), and China (-14.31%).

While some are calling for developed markets to


start outperforming emerging markets in 2011,
the results to the right show that trend
beginning to unfold in 2010.

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Country Market Caps BeSpoke

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MACRO TRENDS
We are in the grip of a great convergence Financial Times, Martin Wolf

Convergent incomes and divergent growth – that is the economic story of our times. We are witnessing
the reversal of the 19th and early 20th century era of divergent incomes. In that epoch, the peoples of
western Europe and their most successful former colonies achieved a huge economic advantage over the
rest of humanity. Now it is being reversed more quickly than it emerged.

What is unprecedented is not convergence, but the scale. Suppose China were to follow Japan‘s path
during the 1950s and 1960s. Then it would still have 20 years of very fast growth in front of it, reaching
some 70 per cent of US output per head by 2030. At that point, its economy would be a little less than
three times as large as <br/>that of the US, at PPP, and larger than that of the US and western Europe
combined. India is further behind. At recent rates of growth, India‘s economy would be about 80 per cent
of that of the US by 2030, though its gross domestic product per head would still be less than a fifth of US
levels

What is unprecedented this time is not convergence, but the scale. Suppose China were to follow Japan‘s
path during the 1950s and 1960s. Then it would still have 20 years of very fast growth in front of it,
reaching some 70 per cent of US output per head by 2030. At that point, its economy would be a little less
than three times as large as that of the US, at PPP, and larger than that of the US and western Europe
combined. India is further behind. At recent rates of growth, India‘s economy would be about 80 per cent
of that of the US by 2030, though its gross domestic product per head would still be less than a fifth of US
levels. China is today where Japan was in 1950, relative to US levels at that time. But its output per head
is far higher in absolute terms, since US levels have themselves risen threefold. Today, China‘s real GDP
per head is roughly where Japan‘s was in the mid-1960s and South Korea‘s in the mid-1980s. India‘s are
where Japan was in the early 1950s and South Korea in the early 1970s.

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In short, today‘s divergent rates of growth between successful emerging economies and the high-income
economies reflects the speed of the convergence of incomes between them. This divergence in growth is
staggering. In an important speech by Ben Bernanke in November the chairman of the US Federal
Reserve, noted that in the second quarter of 2010, the aggregate real output of emerging economies was
41 per cent higher than at the start of 2005. It was 70 per cent higher in China and about 55 per cent
higher in India. But, in the advanced economies, real output was just 5 per cent higher. For emerging
countries, the ―great recession‖ was a blip. For high-income countries, it was calamitous.

The great convergence is a world-transforming event. Today, the west – defined to include western
Europe and its ―colonial offshoots‖ (the US, Canada, Australia and New Zealand) – contains 11 per cent of
the world‘s population. But China and India contain 37 per cent.

The present position of the former group of countries will not be sustained. It is a product of the great
divergence. It will end with the great convergence.

BEGGAR-THY-NEIGHBOR

CURRENCY WARS

US$ ANALYSIS - Key Charts

Currencies: Seven Charts You Should See Money and Markets

The currency market, as well as all markets, have been heavily focused on the U.S. and the Fed‘s plans
for more quantitative easing (QE).
And that‘s had a huge impact on the dollar and on dollar sentiment.
The question is: Will it last?
There‘s no disputing that the dollar is the key to making this ―reflation trade‖ tick. However, there is much
dispute over whether the Fed‘s QE2 plans will work … whether the strategy will produce demand, thus
inflation, and whether it will have a sustainably devaluing effect on the dollar.
Despite all of the mania surrounding the dollar in recent months, history suggests from the Fed‘s last
adventure with QE, that none of aforementioned desired economic outcomes will ultimately pan out from
QE2. Nor will it affect a draconian outcome for the dollar!

For a big picture perspective let‘s take a look at seven key charts to see what may be in store for the
dollar after the QE buzz has faded.

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Chart #1:
Long-term dollar cycles

You can see in the chart below the roughly seven-year cycles in the dollar, dating back to the failure of the
Bretton Woods system 40 years ago. These cycles argue that a bull cycle in the dollar started in March
2008.

That would put the dollar just 2.6 years into its new bull cycle or a bit more than a third of the way
through a typical long-term dollar cycle.
Without question, this recent cycle has been very volatile. But the buck continues to trade comfortably
above its 2008 all-time lows and the lows of last year, making higher lows along the way — a bullish
pattern.

Chart #2:
10-year dollar chart

The chart below shows the roughly seven-year downtrend in the dollar and the subsequent ascending
channel that started in 2008. You can see that the dollar is now testing the bottom line of this bull
channel, an attractive area to buy the greenback.

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A bounce from these levels would project a move toward the top line of the channel or about 23 percent
higher.
Chart #3:
10-year euro chart

This chart for the euro is essentially the inverse of the dollar. And here too, you can see a long multi-year
trend, higher in the case of the euro, followed by a descending channel.

The euro also is bumping into a technical boundary, one that represents a downward trending channel. A
fall from this level of resistance would open up a downside for the euro that would be right on target with
most bearish estimates espoused when the euro zone was at the height of its crisis … parity versus the
dollar.

Chart #4:
Euro‘s 22-week run

For more on the euro, consider this: The euro is in the midst of its strongest 22-week run on record,
surpassing its prior record surge in 2003 — both areas are noted in the chart below.

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What‘s notable here is that in 2003, a 9 percent correction abruptly followed this strong climb. From
current levels in the euro, a similar correction would mean a move down to 1.30 over the next few
months.

Chart #5:
Pound still weak

Despite all of the fuss over the weak dollar, the British pound is still trading nearly 25 percent weaker
against the dollar since the onset of the financial crisis three years ago.

And in the chart above, you can see that while the dollar and the euro are bumping into critical long-term
technical areas, so is the pound.

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Chart #6:
Yen near all-time highs

Now, for the Japanese yen, the other remaining major currency in the world …
This long-term chart in dollar/yen going back 40-years since the failure of the Bretton Woods system,
shows its steady decline.

Even given its recent intervention the pair is nearing all-time lows (lows in the dollar, highs in the yen).
From this chart, compared to the charts of the euro and the pound, you can see the lion‘s share of dollar
weakness over the past few years has come from the surging yen.

And now as this dollar/yen exchange rate nears all-time lows, the Bank of Japan is rolling out its most
aggressive deflation-fighting act yet: With more QE, more fiscal policy and a cut in what‘s left of its
interest rate.

Plus, the Bank of Japan is officially in intervention mode — all things that make a case for a bounce in
dollar/yen.
Finally …

Chart #7:
Battle against the yuan

With the Fed‘s QE2 policy officially on


the table, the emerging market and
Asian countries that have been
waging a fight to keep their
currencies from a runaway surge
have already stepped up with more
currency market intervention and
talks of capital controls.

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And they are doing so because the dollar is weakening. But more importantly they‘re reacting because the
Chinese yuan is getting weaker relative to their currencies in the process — a competitive disadvantage
for their export trade.
The key take-away: A grossly weaker dollar is not an economically or politically acceptable proposition for
the world. And trouble for the world economy represents trouble for the U.S. economy.
So, despite all of the bold projections of a continued rout in the dollar, these seven charts suggest the
exact opposite outcome could be around the corner.

PROTECTIONISM, TARIFFS & CAPITAL CONTROLS

Capital Controls: A Scorecard WSJ

With more and more money pouring into emerging markets, pushing up the value of domestic currencies, more
and more countries are trying to slow down the influx through taxes and regulations. The Institute of International
Finance, a trade association of global banks, put together a handy scorecard of what‘s occurring internationally.
The group list a) the measures taken; b) ―quantitative indicators‖ of the pressure on various currencies and c)
what‘s likely to happen next.

The three indicators are

1) A currency‘s current deviation, in percentage terms, from the 15-year average real effective exchange
rate.
2) The change in value of a particular currency against the U.S. dollar over the past three months.
3) The current difference, in basis points, in key policy rates with the U.S. Fed funds rate (For instance,
Brazil‘s Selic rate is currently 10.75% vs. Fed funds at 0.25%, which produces a difference of 1,050bp).

You can‘t tell the players without a scorecard:

See the pdf that will appear in an upcoming edition of the IIF‘s ―Capital Markets Monitor.‖

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INCREASING GLOBAL INFLATION PRESSURES

Food inflation more important than oil price rises (The threat of rising food prices VOX)

History is adamant on the risks. While much has been made of oil prices as drivers of global inflationary spurts
since the 1970s, recent work of ours (Catão and Chang 2010) provides evidence that food price pressures have
been no less important. The data in fact suggests that food tends to have stronger predictive power on global
inflation cycles than oil.

As Figure 1 illustrates, every single inflation upturn over the past four decades has been preceded (with a one to
two-year lag) by an uptick in world food prices; this causality relation is confirmed by formal econometric tests. To
be sure, one could arguably blame such past slippages on the looser monetary regimes of the 1970s and 1980s.
Yet, later experience indicates that this transmission mechanism remains quite alive in the more recent era of
inflation targeting too.

This is portrayed in Figure 2, which plots the IMF global indices of food and oil prices (measured along the left
vertical axis) against the cross-country median of percentage deviations from the central inflation targets
(measured along the right vertical axis) for all countries that have formally adopted inflation targeting. Clearly, the
large swings since 2006 in deviations of actual from targeted inflation have coincided with attendant swings in
world food prices. Further, Figure 2 also confirms that food prices are better predictors of global inflation than oil
prices. While oil prices began to climb up in earnest from 2003, significant deviations from targeted inflation only
materialised after food prices took off from late 2006. In short, there is substantial evidence – both recent and
well-past – that food prices lurk behind large international swings in inflation rates.

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Inflation Is So Much Worse Than We're Told - Inflation Is So Much Worse Than We're Told Chris Martenson

In just those two errors:

1- Underweighting healthcare
and the

2- Inexplicable gap between


health insurance increases and
the medical care CPI, by my
calculations the BLS is
understating inflation by at
least three percent, and
possibly more.

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FOOD PRICE PRESSURES

Crisis 2011 – Part I: The Other Shoe Eric Janzen

The costs of the Fed‘s pro-inflation policies are largely born by the middle class. High food and gasoline prices,
often dismissed by statisticians as too volatile to include in the CPI, are included in the producer price indexes, and
the trend is clearly up.

Food may only represent 16% of personal consumption expenditures (PCE) for US consumers as a whole, but 4.1%
food price inflation, with 7.5% intermediate food price inflation in the pipeline, is a big deal for a family making
$50,000 a year. That‘s down 4% from $52,000 ten years ago.

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OIL PRICE PRESSURES

Oil breaks through $103 on Egyptian crisis Economic Times

Brent North Sea crude for March soared 88 cents to 103.22 in afternoon Asian trade.

New York's main futures contract, light sweet crude for March, climbed 65 cents to $91.51.

Ken Hasegawa, energy desk manager at Newedge brokerage in Tokyo, said the violent clashes in Egypt prompted
investors to buy oil amid expectations prices could rise further.

What's Behind Egypt's Problems? Oil Drum

Figure 5 shows the close relationship food prices and oil prices. The Food Price Index used in this graph is the
FAO‘s Food Price Index related to food for export; Brent oil prices are spot prices from the EIA.

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US ECONOMY

KEY MONTHLY ECONOMIC INDICATORS – Have a closer look at what the mainline media doesn’t discuss.

Leading Indicator Has Rolled Over


ISM & S&P 500 Divergence - ISM Has Lead S&P

Real Final Sales 6 Quarters after Recession Ends. Transports Breakdown

Commodity Price Index


Consumer Comfort Index - Never Recovered

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2011 US ECONOMIC IMPEDIMENTS

We agree with Hoisington & Lacy and see seven main impediments to economic progress in 2011 that will slow real
GDP expansion to the 1.5%-2.5% range.

1- Fiscal policy actions are neutral for 2011.

- Personal taxes, including federal and non-federal, rose to 9.44% of personal income in
November, up from a low of 9.1% in the second quarter of 2009. Even with the tax compromise
this effective tax rate will continue moving higher as a result of higher state and local taxes.

- Total real federal expenditures are likely to contract (in real terms) this year.

2- State and local sectors will continue to be a drag on the economy and labor markets in 2011.

- Municipal governments face substantial cyclical deficits and significant underfunding of their
employee pension plans.
- Municipal bond yields rose sharply in the second half of 2010 and will continue increasing
borrowing costs. Any trend toward increased bankruptcy would raise caution in the broader
municipal market and add to higher borrowing costs.
- (1) cut personnel; (2) reduce expenditures including retirement benefits; (3) raise taxes; (4)
borrow to fund operating deficits; or (5) declare bankruptcy. All retard economic growth.

3- Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed
continues to encourage additional leverage in an already over-indebted economy.

- Fed actions have affected stock and commodity prices. The benefits from higher stock prices
accrue very slowly, are small, and are slanted to a limited number of households. Conversely,
higher commodity prices serve to raise the cost of many basic necessities that play a major role
in the budget of virtually all low and moderate income households.

4- While consumers boosted economic growth in the second half of 2010 by sharply reducing their
personal saving rate, such actions are not sustainable.

- From 6.3% in June 2010, the personal saving fell by a significant 1%, to 5.3% in November
(Table 1). Consumer spending is slightly in excess of 70% of real GDP. Without the one
percentage point reduction in the personal saving rate, the second half growth rate would have
been 2.6%, a shade slower than the first half growth pace, and materially less than the
presumed second half growth rate.
- When job insecurity is high, and defaults, delinquencies and bankruptcies are at or near record
levels, a drawdown in the saving rate would seem to be an unlikely event.

5- Expanding inventory investment, the main driver of economic growth since the end of the recession in
mid-2009, will be absent in 2011.

- In the second half of 2010, real GDP grew at an estimated 3.3% annual rate (assuming the
fourth quarter growth rate was 4%), up from 2.7% in the first half of the year. Transitory
developments in two of the most erratic and unpredictable components of the economy---the
personal saving rate and inventory investment---accounted for all of this acceleration.
- Inventory investment was the main driver of economic growth since the recession ended in
mid-2009. Based on published data, real GDP grew at a 2.9% annual rate over this span.
However, real final sales, which excludes inventory investment from GDP, increased at a paltry
1.1% pace.
- At a minimum, the dominant source of aggregate economic strength will not repeat in 2011.

6- Housing will continue to be a persistent drag on growth.

- Prices have re-accelerated to the downside over the past four months, as mortgage yields have
risen and the housing overhang has increased.
- As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85% to
their highest level in August 2006. They have since declined 33 percent... In fact, home prices
still must fall 23% if they are to revert to their long-term mean

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7- External economic conditions are likely to retard U.S. exports.

- Higher food and fuel prices will serve to significantly depress growth in countries like China,
India and Brazil where food and fuel are known to be a much higher percentage of household
budgets. Already reports have surfaced from international agencies on the growing adverse
consequences of higher food prices, and social unrest has also been witnessed on a limited basis.
- Chinese economic policy is designed to slow growth and reduce inflationary pressures. Thus,
changing global conditions should serve to moderate U.S. exports.
- A firm dollar will serve to keep U.S. disinflationary trends intact.

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25 Hard Questions That You Will Not See Asked On CNN, MSNBC Or Fox News

There is a reason why so many millions of people are turning to the alternative media for their news today. The
truth is that there are a whole lot of important things that the mainstream media will simply not talk about. There
are a whole lot of other important issues that the mainstream media will tease their viewers with but then
subsequently "whitewash" with the "official story" that none of us is supposed to question. Have you ever noticed
how CNN, MSNBC, Fox News, ABC, NBC and CBS all seem to come up with the exact same version of "the truth"?
But over the past several years we have seen a great awakening take place. Millions of Americans are sick and
tired of being spoon-fed establishment propaganda like a bunch of small children and they are searching on the
Internet for alternative media outlets that are asking the hard questions and that are willing to at least explore
answers that are not part of "the officially sanctioned" version of the truth.

Posted below are 25 hard questions that you will not see asked on CNN, MSNBC or Fox News. Sure, they may
"tease" their viewers by "touching" on some of these issues, but they will never dig deep and they will never ask
the really tough questions that are not "politically correct".

If a tough issue is brought up on one of these networks, it may be debated by a couple of establishment "talking
heads", and we will be told that both sides are being presented so that we can "decide", but it is all a big dog and
pony show. The truth is that the big media companies will never really do anything that threatens the big money
interests that own them or the big money interests that pour billions of advertising dollars into their organizations.
Some of the big news companies may be a little bit more "blue" and some of them may be a little bit more "red",
but the versions of the news that all of them produce are always incredibly similar.

Wouldn't you just love it if the big media companies would tackle some of the questions posted below with some
real honesty?

#1 The U.S. dollar has lost well over 95 percent of its value since the Federal Reserve was created in 1913. The
Fed has failed time and time again from preventing big financial bubbles from being created and then eventually
bursting. About the only thing the Federal Reserve seems to be good at is creating more government debt that the
rest of us have to pay for. So what possible justification is there for allowing the Federal Reserve to continue to
issue our currency and run our economy?

#2 Ten years ago, the "employment rate" in the United States was about 64%. Since then it has been constantly
declining and now the "employment rate" in the United States is only about 58%. So where did all of those jobs
go? Is this what we can expect from "globalism"?

#3 Thousands of dead birds are falling out of the sky and millions of dead fish are washing ashore all over the
globe. So does this mean that there is something seriously wrong with the planet?

#4 If the U.S. economy is getting better, then why did the number of Americans filing for bankruptcy rise another
9 percent in 2010? Why won't our government officials be straight with us and tell us the real truth about the
economy?

#5 Would a failure to raise the debt ceiling really "have catastrophic economic consequences that would last for
decades" or is U.S. Treasury Secretary Timothy Geithner just blowing off a lot of hot air again?

#6 If 71 percent of the American people are against it, and only 18 percent of them are for it, then why in the
world are our representatives in Congress overwhelmingly in favor of raising the debt ceiling again?

#7 Will a combination of extreme weather, soaring agricultural commodity prices and rising oil prices lead to a
devastating global food shortage at some point in the next few years?

#8 In Algeria, hordes of young people are throwing fire bombs and are shouting slogans such as "Bring us Sugar!"
Are these the kinds of food riots that we should expect to see around the globe as food gets tight this year?

#9 Over the last couple of years, lawmakers in at least 10 U.S. states have introduced legislation that would allow
state commerce to be conducted with gold and silver coins. Could this be the beginning of a new trend?

#10 When German Chancellor Angela Merkel says that Germany will do "whatever is needed to support the euro"
is that supposed to make all of us feel better about the stability of the failing European currency? If the Euro does
fail, won't that cause another financial meltdown like we saw back in 2008?

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#11 Back in 1970, 25 percent of all jobs in the United States were manufacturing jobs. Today, only 9 percent of
the jobs in the United States are manufacturing jobs. How in the world could we allow that to happen?

#12 According to a recent Gallup survey, 7 out of every 10 Americans believe that religion is losing influence in the
United States. So exactly what does that say about our society?

#13 Now that the State of Illinois has passed a 66 percent increase in the state income tax, how long will it be
before other states start passing draconian income tax hikes?
#14 Shouldn't we be at least a little bit concerned that China has developed a new ballistic missile that can
completely destroy a U.S. aircraft carrier nearly 2,000 miles out to sea? Has China become a military threat that
we need to start taking very, very seriously?

#15 In 2006, no U.S. banks failed. In 2009, 140 U.S. banks failed. So did things get better in 2010? No. In
2010, 157 U.S. banks failed. Do does that mean our financial system is getting healthier or does that mean our
financial system is coming apart at the seams?

#16 On January 1st, the very first of the Baby Boomers started to reach the age of 65. Now more than 10,000
Baby Boomers will be turning 65 every single day for the next 19 years. So where in the world are we going to get
all the money we need to pay them the retirement benefits that we have promised them? Isn't the Social Security
system essentially one gigantic Ponzi scheme?

#17 According to a shocking recent survey, 40 percent of all U.S. doctors plan to bail out of the profession over
the next three years. So how in the world is our health care system going to continue to function if that happens?

#18 Why is the federal government spending approximately 6.85 million dollars per minute if our founders
intended for us to have a "limited central government"?

#19 Should we be glad that the U.S. Department of Health and Human Services and the U.S. Environmental
Protection Agency want to lower the amount of fluoride in our drinking water, or should we be furious with them
for poisoning us with super high levels of fluoride for all of these years?
#20 The U.S. trade deficit with China during the month of August alone was more than 4,600 times larger than the
U.S. trade deficit with China was for the entire year of 1985. Do you think perhaps we should all not be buying so
much stuff with "made in China" stamped on it?

#21 If the federal government stopped all borrowing today and began right at this moment to repay the U.S.
national debt at a rate of one dollar per second, it would take over 440,000 years to pay off the U.S. national
debt. So does anyone out there actually still believe that the U.S. national debt will be paid off someday?

#22 1180 new snowfall records were set in the United States just this past week. So does that mean that global
warming isn't true after all?

#23 If the U.S. economy is getting better, then why are an all-time record 43.2 million Americans now on food
stamps? Are middle class Americans being impoverished by design?

#24 What in the world will a "security perimeter" around the United States and Canada actually look like? Are our
leaders slowly trying to turn North America into another version of the EU?

#25 How in the world can Facebook be worth 50 billion dollars? Is Goldman Sachs trying to pull a big joke on all
the rest of us?

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PUBLIC POLICY MISCUES

Confidence Game 2011 - The Year of Catch-22 Jim Quinn

Ben Bernanke, Timothy Geithner, Barack Obama, the Wall Street banks, and the corporate mainstream
media are playing a giant confidence game. It is a desperate gamble. The plan has been to convince the
population of the US that the economy is in full recovery mode. By convincing the masses that things are
recovering, they will begin to spend and buy stocks. If they spend, companies will gain confidence and
start hiring workers. More jobs will create increasing confidence, reinforcing the recovery story, and
leading to the stock market soaring to new heights. As the market rises, the average Joe will be drawn
into the market and it will go higher. Tax revenues will rise as corporate profits, wages and capital gains
increase. This will reduce the deficit. This is the plan and it appears to be working so far. But, Catch 22
will kick in during 2011.

The United States and its leaders are stuck in their own Catch 22. They need the economy to improve in
order to generate jobs, but the economy can only improve if people have jobs. They need the economy to
recover in order to improve our deficit situation, but if the economy really recovers long term interest
rates will increase, further depressing the housing market and increasing the interest expense burden for
the US, therefore increasing the deficit. A recovering economy would result in more production and
consumption, which would result in more oil consumption driving the price above $100 per barrel,
therefore depressing the economy. Americans must save for their retirements as 10,000 Baby Boomers
turn 65 every day, but if the savings rate goes back to 10%, the economy will collapse due to lack of
consumption. Consumer expenditures account for 71% of GDP and need to revert back to 65% for the US
to have a balanced sustainable economy, but a reduction in consumer spending will push the US back into
recession, reducing tax revenues and increasing deficits. You can see why Catch 22 is the theme for 2011.

The government‘s confidence game is destined to fail due to Catch-22. Will the consensus forecast of a
growing economy, rising corporate profits, 10% to 15% stock market gains, 2 million new jobs, and a
housing recovery come true in 2011? No it will not.

By mid-year confidence in Ben‘s master plan will wane. He is trapped in the paradox of Catch-22. When
you start hearing about QE3 you‘ll know that the gig is up. If Bernanke is foolish enough to propose QE3
you can expect gold, silver and oil to go parabolic. Enjoy 2011. I don‘t think Ben Bernanke will .

True Money Supply The Bernanke arbitrage Pollaro

A formulation based on the monetary insights of the Austrian School of economics.

Steve Saville, editor of the excellent The


Speculative Investor newsletter and
fellow TMS tracker, summed up the
issue beautifully in a recent letter when
he said:

…we don’t think that Bernanke is lying


when he says that the US money supply
hasn’t grown by much over the past 1-2
years. The problem, we suspect, is that
he doesn’t know how to measure the
money supply, which is possibly worse
for the US economy than if he
understood what was going on but was
deliberately hiding the truth. If he knew
there was a monetary inflation problem,
but was lying about it, there would be a
chance of corrective measures being
implemented sooner rather than later.
Instead, he feels comfortable promoting
more monetary inflation because he
truly believes that the current inflation
rate is low.

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DEBT CEILING POLITICS

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Interest payments as a percentage of our total government outlays has declined pretty dramatically since 1980.

Interest payments as a percentage of tax receipts

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Interest payments as a percentage of GDP.

Borrowing has gotten much, MUCH, cheaper since those days. The red line is the yield on the 10-year Treasury

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Why?
1- Lower Interest Rates
PLUS
2- shorter maturities on Government Debt ( ie 1 year OptionARM versus 30 Fixed Rate Mortgage)
How The US Could Lose Its AAA Status By The End Of 2011 Clusterstock

There's a lot of talk about the debt ceiling right now, but the major worry surrounding markets is the
potential for a U.S. downgrade. While Societe Generale don't think we're going to flirt with a downgrade
over Republican opposition to the debt ceiling, they do think we already are anyway. It's just a matter of
when, and how fast interest rates rise on our borrowing. Assuming the Bush tax cuts are extended, 200
bp hike in interest rates would push us into AA territory before the end of 2011. A 50 basis point hike
would see use there by 2014.

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STILL MORE REAL ESTATE PROBLEMS LOOMING

Let‘s take a look at the situation after the data from the Case-Shiller home price index has come in:

You see all major metropolitan areas peaking between March and May 2010 (the end of the first-time home-buyer
tax credit). After only 8 months in positive territory, the overall index comprising 20 cities is back into the red (-1%
in October). 14 out of 20 regions now show declining house prices.

Prof. Robert Shiller (one of the creators of the index) pointed out that 6 out of 20 cities in the index have hit new
lows (even lower than in early 2009). He said that the economy would face “serious worries” if house prices
kept falling this fast

Why did he say ―this fast‖? To understand, you have to look at the annualized rate of change of the last 3 month.
And it is not a pretty picture:

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While the 10-city index dropped an annualized 8.8% in the three-month period from July to October 2010, the 20-
city index fell at a rate of 10.4%.

The annualized three-month rate of change gave an early warning sign went it went into negative territory in June
2006, while both the 10-city and 20-city only showed declining house prices in January of 2007.
Equally, the three-month rate of change signaled a trend reversal in April, May and June of 2009, while the overall
index did not turn positive until February 2010.

Investors would have been wise to heed these signals – both on the way down and on the way up. As declining
house prices were the trigger[4] for the biggest financial crisis since the Great Depression it is only a matter of
time until financial markets react to the new realities of house prices: a double-dip.

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RESIDENTIAL REAL ESTATE

Nearly 11 Percent of US Houses Empty Nearly 11% of Houses Empty CNBC

HOME OWNERSHIP

- America's home ownership rate, after holding steady for a while, took a pretty big plunge in Q4, from
66.9 percent to 66.5 percent.
- That's down from the 2004 peak of 69.2 percent and the lowest level since 1998.

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- Homeownership is falling at an alarming pace, despite the fact that home prices have fallen, affordability
is much improved and inventories of new and existing homes are still running quite high.
- Bargains abound, but few are interested or eligible to take advantage.

OCCUPANCY RATE

- Of the nearly 131 million housing units in this country:


- 112.5 million are occupied.
- 74.8 million are owned - only dropped by about 30 thousand in the past year.
- 38 million are rented, but that's up by over a million year over year.
- That means more new households are choosing to rent.

VACANCY RATE

- More concerning than the home ownership rate is the vacancy rate.
- There were 18.4 million vacant homes in the U.S. in Q4 '10 (11 percent of all housing units vacant all
year round), which is actually an improvement of 427,000 from a year ago, but not for the reasons you'd
think.
- The number of vacant homes for rent fell by 493 thousand, as rental demand rose.
- 471,000 homes are listed as "Held off Market" about half for temporary use, but the other half are likely
foreclosures. And no, the shadow inventory isn't just 200,000, it's far higher than that.

So think about it. Eleven percent of the houses in America are empty. This as builders start to get more bullish,
and renting apartments becomes ever more popular. Vacancies in the apartment sector have been falling steadily
and dramatically, why? Because we're still recovering emotionally from the toll of the housing crash.

Younger Americans have seen what home ownership has done to their friends and families, and many want no part
of it. Credit has become very nearly elitist. Home prices, whatever your particular data provider preference might
be, are still falling.

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Boom's Home-Ownership Gains Lost Boom's Home-Ownership Gains Lost WSJ

The meltdown of the U.S. mortgage market and rising foreclosures have wiped out more homeowners
than were created in the 2000-07 housing boom, some industry watchers say, the latest indication of the
severity of the housing bust.

In the fourth quarter of 2010, 66.5% of Americans owned homes, down from 67.2% a year earlier and the
lowest rate since the end of 1998, according the Census Bureau. During the boom, when easy credit made
mortgages available with less regard for income or ability to pay, the ownership rate surged to a record
69.2% in 2004's second and fourth quarters and stayed near that level until the recession deepened.

Some industry watchers expect the rate to slip below 65% as the housing market meltdown forces
millions more Americans to give up their homes.

That "shows how big the bubble was and how catastrophic the bursting has been," said Paul Dales, senior
U.S. economist with Capital Economics. "We have pretty much reversed all of the increases in the home-
owner rate generated by the housing boom."

The nation's homeownership rate gained 0.8 percentage points from 2000 to 2007, but has lost 1.3
percentage points since 2007, erasing the boom's gains, said Stephen East, a Ticonderoga Securities
housing analyst.

The first wave of trouble struck several years ago as borrowers took out so-called subprime mortgages
with low interest rates that later reset, often with much higher payments that they couldn't afford. The
problem spread as the recession led to high unemployment. Now, as declining real-estate values leave
many borrowers owning more than their homes are worth, more Americans are simply walking away.

The changes in the market are taking a toll on minority ownership. Just 44.8% of black-only households
were homeowners in the fourth quarter of 2010, down from 46% a year earlier. The rate for Hispanics
also fell, to 46.8% from 48.4%, the Census showed. The rate for white, non-Hispanic households slipped
to 74.2%, from 74.5%.

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The downturn is most pronounced in the West, which was dramatically overbuilt during the market boom
and continues to see high foreclosure rates. It registered the nation's lowest ownership rate, at 61%,
down from 62.3% a year earlier. The Midwest had the highest percentage of homeowners among regions,
but it also saw a year-over-year decline, to 70.5% from 71.3%.

The vacancy rate for rental housing fell to 9.4%, from 10.7% a year earlier. Housing experts say each 1%
decline in the home-ownership rate represents the movement of one million households to rentals.

With demand expected to surge, developers are ramping up apartment construction. CoStar Group, a
commercial real-estate data and analysis provider, expects about 23,000 multifamily units to be
completed this year, followed by nearly 95,000 in 2012 and more than 109,000 in 2013.

"Americans are going through a fundamental transition in the way they look at rental housing," said Greg
Kraus, senior director of acquisitions with Invesco Real Estate, which has spent more than $1 billion on
apartment communities in the last 15 months. "Historically, there's almost been a subtle disdain in many
markets if you're a renter. That stigma is going to go away."

Banks still holding 70% of REO from market Banks still holding 70% of REO from market Housing Wire

RealtyTrac Senior Vice President Rick Sharga said major banks:

- currently hold roughly 1 million REO, or homes repossessed through foreclosure,


- only 30% have actually made it onto the market.
- foreclosure filings reached a new high in 2010 and should climb even higher this year, possibly
surpassing 4 million filings.
- that's not counting the more than 5 million delinquent loans that have yet to enter the initial
stages of the foreclosure process

"I think you're looking at a 2011 that will be worse than 2010, then some stabilization through 2012. In
2013, you'll see a more manageable number of REO,"

Sharga told HousingWire Saturday at the REO CON default industry education summit in Fort Worth,
Texas.

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The major kink in the housing market's recovery, and for the macro economy overall, is the work left to
be done on homes currently in the foreclosure process, those about to enter it and the amount of
repossessed homes the banks must shed. Striking a proper balance on how to mange this shadow
inventory of foreclosures is vital for the banks to show a healthy balance sheet while not dumping too
many distressed properties onto the market, further dragging down home prices and values.

A recent study from Morgan Stanley showed the shadow inventory, those properties facing imminent
default, evolving from mostly subprime and Alt-A loans to containing more prime loans as elevated
unemployment levels have pushed more homeowners behind on their mortgage.
Analysts said that some 8 million repossessions would need to be liquidated over the next five
years before the market stabilizes.

Adding to the problem are recent issues the banks are having processing the paperwork. In October, the
banks had to hold up foreclosures to refile affidavits signed improperly in many states, pushing more than
250,000 foreclosure cases into 2011. Reports recently showed that the problem may have spread to the
notices of default as well.

As RealtyTrac employees have found, notices of default "dropped off a cliff" late last year and are still off
in January, Sharga said.

And in the 23 states where lenders must foreclose on a homeowner through the court system, backlogs of
cases have formed month-long delays. Sharga said a court clerk in Florida, one of the states with the
longest traffic jams, told him between 500,000 and 600,000 cases are yet to be heard.

Sharga said he's encouraged by the uptick in demand for REO. "We've seen more traffic on our site, and
even more buyers raising their hand asking for help from a Realtor," he said. "This means they're getting
serious about buying again." He also said that the most traffic comes from Southwestern states and
Florida.But Sharga said there is plenty of work to be done, and that any further delays in the process will
only set back an already postponed recovery. "It won't feel normal again until about 2013," Sharga said.

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COMMERCIAL REAL ESTATE

Don't Tune Out the Commercials Brian Pretti

2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.

2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over
the half decade ahead at least.

Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced
loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate
mortgage maturities occurred. In the next three years we have four times that much paper coming due.

Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the
commercial banking conduit?

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Will the regulators force the large banks to show any increase in loan impairment. Again, given the
incredible political clout of the financial sector, I doubt it.

We have experienced one of the most robust corporate profit recoveries on record over the last half
century. We know reported financial sector earnings are questionable at best, but the regulators will do
absolutely nothing to change that. So once again we find ourselves in a period of Fed sponsored
asset appreciation. The thought, of course, being that if stock prices levitate so will consumer
confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of
economic growth.

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MARKET ANALYTICS

HIGHLIGHTS - What You Need to Know

We appear to have a 'rolling top' with broad based weakening analytics and cascading warning signals. This
behavior is often seen near major tops. The Friday 01-28-11 sell-off is the initiation of a short term correction and
consolidation before we put in a final new high as part of this final topping formation and long term right shoulder
construction pattern.

The market action since March 2009 is a bear market counter rally that will end with a classic ending diagonal
pattern. The Bear Market which started in 2000 will resume in full force by the spring of 2011.

Highlight examples of weakening analytics and warning signals are as follows:

- Growing Dow Theory non-confirmation between the Dow Industrials and the Trannies

- Inter-market Divergence with new highs in the Blue Chip DOW Industrials with lower closes in the S&P
500, Nasdaq, Russell 2000 and Trannies

- Extreme Bullish Sentiment indicators

- VIX Sell Signal

- Confirmed Hindenberg Omen from December

- Weakening Breadth - 10 DMA A/D Line versus NYSE, NDX and Russell 2000 price.

- Rising Termination Wedge pattern in the Industrials and S&P 500 since the July 2010 lows.

CURRENT MACRO EXPECTATIONS

OUR CURRENT MACRO EXPECTATIONS FOR FINANCIAL EQUITY MARKETS


The following schematic best represents the US S&P 500 Stock Index

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BIG PICTURE

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It will take more time to put in the Right Shoulder

OUR APPROACH

We take a completely different approach to Techno-Fundamental Analysis. It is best summarized as follows:

TIME FRAME DURATION APPROACH KEY TOOLS

Short Term Less than 90 Days Technical Analysis Elliott Wave Principle, WD Gann,
JD Hurst, Bradley Model,
Proprietary Mandelbrot Fractal
Generator
Intermediate 12 Months Risk Analysis Global Macro Analysis
Tipping Points - Pivots
Longer Term 18 Months + Fundamental Analysis Financial Metrics

The Global Macro Analysis, which is so prevalent in our articles and on


our Tipping Points site, plays the critical role of bridging our highly
analytic Technical Analysis with our detailed Fundamental Analysis.

We have found that in the short term the markets are driven by
emotion and sentiment. In the longer term, they are driven by
financial fundamentals. As Warren Buffett is often quoted as saying:
―In the short term the market is a slot machine but in the long term it
is a weighing machine.‖ We have found that the transition shows a lagging correlation between changes in the
Global Macro, followed by Corporate Earnings, then followed by the sell side analyst community estimates.

Our focus within the Global Macro is:


i) Quantification of Risk,
ii) Establishment of pivots through the mapping of Tipping Points
iii) Identification of ever shifting competitive financial drivers to corporate profitability

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SHORT TERM – Technical Analysis
"Investors are beginning to feel more confident in the economic recovery and believe that equity prices have
but one direction to move."

The market has risen 86% over the last 21 months without a significant Fibonacci correction or consolidation. This
is extremely unusual and a strong indicator the market is due for a rest.

The market looks overbought and overextended, and is showing signs of an imminent top with:

1- Lagging breadth,
2- A lower number of new highs,
3- Overenthusiastic sentiment,
4- Higher-volume down days and
5- A more frequent number of late-day selloffs.

In the short term we think that potential upside progress is limited while downside corrective risk is high.

Gann

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Elliott Wave

All typical Elliott Wave Analysis is signaling a major multi-year reversal. We disagree that it is imminent.

A final ongoing period of higher level correction & consolidation is in the works before this bear market counter
rally that started in March 2009 is complete.

The detailed tradable Elliott Wave count which specifically aligns with the Gann Analysis above we share with our
clients only.

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Channels

The consolidation / correction stage is drawing to a close and will likely end with a retest of the 200 Day Moving
Average which will act as a launch pad for the final "Minsky Melt-Up" wave.

The 200 DMA test will be approximately 1160 in the S& P 500. This also correlates to a 38.2% Fibonacci
retracement since the July 1st lows.

Cycles - Bradley Model

The Bradley Model is a highly proprietary technical analysis


methodology. The Bradley Model is signaling that the
current correction ends in late Match with final leg finishing
by June 2011. The finishing high matches precisely our
analysis.

We are restricted in showing you the Bradley Model but we


can give you a 'blurred' view as depicted to the right.

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Sentiment

Investors Intelligence

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American Association of Independent Investors

As shown in the first chart below, the S&P 500 remains at the very top of its trading range, which is two standard
deviations above the index's 50-day moving average. But even though the market is this overbought, only 78% of
the stocks in the index are trading above their 50-day moving averages. When the index has been at similar
elevated levels over the past year, the percentage of stocks above their 50-days has typically been in the high 80s.
The low reading this time around means not all stocks have been participating in the current rally, which is not a
good thing.

This week‘s surveys of bullish sentiment from Investors Intelligence (II) and the American Association of Individual
Investors (AAII) showed the ninth highest combined reading since 1987, and it was the sixth period ever where the
combined reading was above 120%. One place where the holiday spirit is not in short supply is the equity market.

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National Association of Active Investment Managers (NAAIM)

The National Association of Active Investment Managers (NAAIM) shows that on average they are 81.83%
invested.

This is in the high end of the range and shows that these managers are quite bullish.

Sum of Variant Perception Sell Signals

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Smart Money / Dumb Money Confidence

Options Speculation Index

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Short Interest - Percentage of Float

Notice the line going back to just prior to the crash when euphoria was at its highest!

Some would argue that short interest is only now returning to historical norms after the mayhem of the Lehman
crisis. But we differ. Elevated short interest levels are nearly always a precondition of a bull market, forming the
requisite 'wall of worry' upon which stocks climb. The opposite is also the case. Depressed short interest is
regularly a harbinger of an imminent slide in stocks.

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Oscillators & Breadth Indicators of Importance

Price Momentum Oscillator (PMO)

The PMO oscillates around a zero line, which acts as a magnet. A reduction in price acceleration can cause the PMO
to reverse course even as price moves higher. The following is a PMO Analysis chart for the 100 Dow Jones US
Sectors, which is an excellent sample of a broad range of asset classes. Note two bracketed time frames that show
a gradual deterioration of the Percentage of PMO Crossover Buy Signals, each having a rapid decline in PMO buy
signals at the end of the period -- meaning there would have been a large cluster of sell signals over a period of
several days. Note that prices continued higher during those periods.

PMO Sell Signal Clusters Carl Swenlin - Decision Point 01-28-11

The Percentage of PMO Crossover Buy Signals Index is best used in conjunction with the PMO for the price index, in
this case the Wilshire 5000. Currently it is overbought and moving sideways in a manner that often precedes price
corrections. Clusters of PMO buy or sell signals identify climactic activity. Further investigation is needed to
determine if the current price trend has been exhausted, or if a new trend has been initiated.

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NYSE Overbought / Oversold

OEX Open Interest (Puts/Calls)

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Both of the charts above indicate we are tracking as expected and there is still another leg down as part of a final
ending diagonal pattern. Watch the TRIN and McClellan Oscillators. Both are signaling a tradable reversal.

TRIN

McClellan Oscillator

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INTERMEDIATE TERM – Risk Analysis

The dramatic rise in the 10 Year US Treasury following the November 3rd FOMC Q2 press release is nothing short
of dramatic. However, it has recently begun to stall. You can be assured the US Federal Reserve has more 'bullets'
ready to hold yields down!

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Margin Levels

Margin debt is one measure of the amount of optimism or pessimism in the stock market. Rising margin debt
generally correlates to a rising stock market. Margin use has soared to the highest level since September 2008 .

Margin Debt Data is from NYSE Fact book Securities Credit

NYSE October Margin Debt Jumps To Highest Since Lehman Failure As Investor Net Worth Is At Lowest Since April
Highs Zero Hedge

It is not just the stock market that is at the highest levels since Lehman. Probably just as importantly,
NYSE margin debt has surged to $269 billion, an increase of $13 billion from the prior month, and the
highest since September 2008 when it was at $299 billion, and subsequently tumbled as investors rushed
to get out of all margined positions. And this has happened even free cash credit accounts and credit
balance in margin accounts remained relatively flat. In other words, net NYSE available cash decreased by
$10 billion M/M to ($34) billion, the lowest since April 2010, just before the market tumbled, and net cash
surged by almost $50 billion in two months. We are confident that NYSE cash in November will be at the
lowest level of the year, not to mention December, as hedge funds leveraged everything they could, in
some cases hitting as much as 3-4x gross leverage, in pursuit of beta, now that unleveraged alpha
strategies have ceased to work. Which means that with retail stubbornly missing from the picture, the
only beneficiaries of the HFT and Fed facilitated melt up are the 1000 or so hedge funds, where average
net worth is in the 6 digits, that will be profitable this year. Everyone else can drown their sorrows in
McDonalds fries which are about to surge in price. Of course, what this means should some unexpected
credit event occur, is that the forced selling that will follow this two year high margin debt unwind will lead
to a comparable results as those seen after the Lehman collapse.

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According to Mish in Margin Debt Soars to Highest Levels Since September 2008
mutual fund cash levels have been near record lows since September, and topping it off, a respected friend tells
me NYSE cash levels are negative $35 billion.

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VIX / VXO Warnings

We have an initial breakout of the VIX.

There have been a number of warnings that this was coming and would be associated with a correction in the
market.

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Adam Hamilton at Zeal does a very nice job of linking the VIX to the Bullish Percentage Indicator to the Put Call
Ratio (PCR) 21 DMA in his analysis SPX Correction Looms

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Barron's also warned that volatility could spike in Why Volatility Could Spike

Risk premiums, as measured by the Chicago Board Options Exchange Volatility Index, are too low now,
given the cross-currents roiling the surface of the stock market. This typically marks a good time to buy
defensive index options to hedge against broad-market declines and volatility spikes. With VIX around 18,
Jim Strugger, MKM Partners' derivatives strategist, is telling clients to buy VIX Feb. 21 calls and sell VIX
Feb. 30 calls to protect against an earnings-season volatility spike that could temporarily interrupt the bull
advance. "After being bullish on equities since late August, and riding this volatility wave lower, we're
saying, 'get ready for a VIX spike to 30,' " Strugger says.

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37 Trading Days Without a Correction

Streak Snapped at 37 Trading Days BeSpoke

January 19's S&P 500 decline of just over 1% was the first of its kind since before Thanksgiving. The index
held out just long enough to eclipse the 36-trading day period without a 1% decline back in March and
April of last year. The 37-day streak that just came to an end was the longest since May 2007. But 37
trading days without a 1% decline is nothing compared to the 94 trading days seen back in 2006. While
volatility has dropped quite a bit over the past few months, it's still nothing compared to the quiet trading
seen for multiple years in the middle of the last decade.

A Classic 'Tell-Tale' Divergence to Watch

The Divergence to Keep on Your Radar The Divergence to Keep on Your Radar

The Russell 2000 began its 4.26 percent swan dive at the open on Wednesday 01-19-11 to close at its
lows on Friday 01-21-11 (Options Expiration). Meanwhile, the Dow Jones Industrial Average closed up
0.72 percent for the week led by big gains in GE, IBM, Hewlett Packard, and Exxon.

We suspect this just may be profit taking from the Russell‘s huge run-up in 2010 as many of the stocks
that were up big over the past year also got whacked during the week. The size of the divergence does
raise a red flag, however.

Only twice in the past seven years has the Dow and Russell experienced close to a 5.0 percent
performance divergence in just four trading days and those occurred in 4Q 2008, during the height of
financial collapse. The Russell 2000 is a favorite hedging and shorting vehicle for the fast money crowd
and the divergence may be a false signal as the shorts rush to cover, but it‘s worth keeping on your
radar.

The last chart also shows that the two bull markets of the new millennium, reflected in the S&P500, have
been confirmed by the Russell 2000 outperforming the Dow. The converse is true during bear markets.
The S&P500 can continue to rally even as the Russell:Dow ratio turns down, but it‘s clear the ratio is a
leading indicator of major trend reversals and deeper corrections.

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LONGER TERM - Fundamental Analysis

Warning - An Updated Who's Who of Awful Times to Invest Hussman

The following set of conditions is one way to capture the basic "overvalued, overbought, overbullish, rising-yields"
syndrome:

1) S&P 500 more than 8% above its 52 week (exponential) average


2) S&P 500 more than 50% above its 4-year low
3) Shiller P/E greater than 18
4) 10-year Treasury yield higher than 6 months earlier
5) Advisory bullishness > 47%, with bearishness < 27% (Investor's Intelligence)

[These are observationally equivalent to criteria I noted in the July 16, 2007 comment, A Who's Who of Awful
Times to Invest. The Shiller P/E is used in place of the price/peak earnings ratio (as the latter can be corrupted
when prior peak earnings reflect unusually elevated profit margins). Also, it's sufficient for the market to have
advanced substantially from its 4-year low, regardless of whether that advance represents a 4-year high. I've
added elevated bullish sentiment with a 20 point spread to capture the "overbullish" part of the syndrome, which
doesn't change the set of warnings, but narrows the number of weeks at each peak to the most extreme
observations].

The historical instances corresponding to these conditions are as follows:

December 1972 - January 1973 (followed by a 48% collapse over the next 21 months)

August - September 1987 (followed by a 34% plunge over the following 3 months)

July 1998 (followed abruptly by an 18% loss over the following 3 months)

July 1999 (followed by a 12% market loss over the next 3 months)

January 2000 (followed by a spike 10% loss over the next 6 weeks)

March 2000 (followed by a spike loss of 12% over 3 weeks, and a 49% loss into 2002)

July 2007 (followed by a 57% market plunge over the following 21 months)

January 2010 (followed by a 7% "air pocket" loss over the next 4 weeks)

April 2010 (followed by a 17% market loss over the following 3 months)

December 2010

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Rule of 20

3 Market Valuation Indicators Screaming Caution

Doug Short is the CEO of Dshort.com. and his analysis in Three Big Market Valuation Indicators Are All Screaming
Caution is worth careful consideration

Let's check out the latest overlays of the three valuation indicators I routinely follow. Here are links to some
background explanation.

 The relationship of the S&P Composite to a regression trendline (more)


 The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
 The Q Ratio — the total price of the market divided by its replacement cost (more)

To facilitate comparisons, I've adjusted the Q Ratio and P/E10 to their arithmetic mean, which I represent as
zero. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value,
which I'm using as a surrogate for fair value. Based on the latest S&P 500 monthly data, the index is
overvalued by 62%, 43% or 38%, depending on which of the three metrics you choose.
I've plotted the S&P regression data as an area chart type rather than a line to make the comparisons a bit
easier to read. It also reinforces the difference between the two line charts — both being simple ratios — and
the regression series, which measures the distance from an exponential regression on a log chart.

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The chart below differs from the one above in that the two valuation ratios (P/E and Q) are adjusted to
their geometric mean rather than their arithmetic mean (which is what most people think of as the
"average"). The geometric mean weights the central tendency of a series of numbers, thus calling
attention to outliers. In my view, the first chart does a satisfactory job of illustrating these three
approaches to market valuation, but I've included the geometric variant as an interesting alternative view
for P/E and Q.

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Hazards Of Using Estimated Forward Operating Earnings Comstock Funds

Many investors are confused when they hear the vast majority of portfolio managers and strategists in the
media say that the stock market is cheap while the minority bears assert that it is significantly overvalued.
After all, aren't the two sides looking at the same facts? Well, yes and no. The bears look at trailing
cyclically-smoothed reported (GAAP) earnings for the S&P 500, a number that we calculate at about $68
for the year ended 2010. The bulls, on the other hand use estimated 2011 consensus operating earnings
of $95. On today's closing price of the index of 1283, we calculate the P/E ratio on $68 at about 19 times,
while the bulls divide 1283 by their 2011 estimate and come up with a P/E ratio of 13.5 times. Since both
sides are aware that the long-term average P/E ratio is about 15 we see overvaluation where the bulls see
undervaluation.

We have three major problems with the way the majority determines the value of the market. First,
operating earnings differ significantly from earnings calculated in accordance with "generally accepted
accounting principles", commonly referred to as "GAAP" or "reported" earnings. Operating earnings throw
back into earnings a number of expenses considered non-recurring such as severance pay, plant closings,
inventory write-downs and any number of other expenses that corporations may want to write off. In the
past ten or fifteen years companies have gotten a lot more creative about what items they can write off,
and now a large number of expenses that used to be considered normal are called unusual even when
these write-offs are taken year after year. In other words, in too many cases what is called operating
earnings is pure fiction. That is why we prefer to use earnings calculated in accordance with generally
accepted accounting principles.

Second, the long-term average P/E ratio of 15 is based on trailing reported earnings, not operating
earnings. Prior to the last dozen years of sequential bubbles the 71-year average P/E on this basis was
14.5 (rounded to 15). Operating earnings as they are used today did not even exist until the mid-80s
when they came into vogue partly as a means of making earnings look better than they would have under
the accepted rules. Since operating earnings almost always exceed reported earnings, often by significant

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amounts, even if we had such results going back further in history, the average P/E on them would be
much lower than for reported earnings. For instance in the last 12 years cumulative operating earnings
exceeded reported earnings by 23%. This would be enough to reduce a 15 P/E ratio to about 12. In that
case the market would be overvalued even on operating earnings.

Third, but not least, estimates of operating earnings a year ahead are notoriously unreliable. In the last
12 years such forecasts have missed the target by an average of 23% in either direction, and some of
these misses were laughable. At year-end 2007 the consensus estimate of S&P 500 operating earnings
for 2008 was $89. At the end of May 2008, five months into the year, the estimate was still at $89 (see
Barron's article May 26, 2008 on home page "What is the Real P/E Ratio?"). Even at the end of October,
only two months away from year-end the estimate was at $72. The actual number came in at slightly
under $50 just a short while later.

The estimate of operating earnings for 2009 turned out to be just as ludicrous as for 2008. In May 2008
the consensus estimate for 2009 was as high as $110. At year-end 2008, when the extent of the credit
crisis was already known for months, the 2009 estimate had only come down to $99. It ended up far
lower at $57.

In sum the use of 12-month forward operating earnings to determine the value of the market can be
extremely hazardous. In our view the market is selling at about 19 times reported trailing cyclically-
smoothed earnings, about 26% higher than the average historical multiple of 15, let alone the average
multiple of 7-to-10 seen at the bottom of past secular bear markets. At present levels the market is
already discounting an optimistic outlook and is highly vulnerable to any of the serious global problems
that can come to the fore at any time.

Q Ratio

Doug Short is the CEO of Dshort.com.

The Q Ratio is a popular method of estimating the fair value of the stock market developed by Nobel Laureate
James Tobin. It's a fairly simple concept, but laborious to calculate. The Q Ratio is the total price of the market
divided by the replacement cost of all its companies. The data for making the calculation comes from the Federal
Reserve Z.1 Flow of Funds Accounts of the United States, which is released quarterly for data that is already over
two months old.

The first chart shows Q Ratio from 1900 through the first quarter of 2010. I've also extrapolated the ratio since the
end of Q3 based on the price of VTI, the Vanguard Total Market ETF, to give a more up-to-date estimate.

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Interpreting the Ratio
The data since 1945 is a simple calculation using data from the Federal Reserve Z.1 Statistical Release, section
B.102., Balance Sheet and Reconciliation Tables for Nonfinancial Corporate Business. Specifically it is the ratio of
Line 35 (Market Value) divided by Line 32 (Replacement Cost). It might seem logical that fair value would be a 1:1
ratio. But that has not historically been the case. The explanation, according to Smithers & Co. (more about them
later) is that "the replacement cost of company assets is overstated. This is because the long-term real return on
corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is
around 6.0%. Over the long-term and in equilibrium, the two must be the same."

The average (arithmetic mean) Q ratio is about 0.70. In the chart below I've adjusted the Q Ratio to an arithmetic
mean of 1 (i.e., divided the ratio data points by the average). This gives a more intuitive sense to the numbers. For
example, the all-time Q Ratio high at the peak of the Tech Bubble was 1.82 — which suggests that the market
price was 158% above the historic average of replacement cost. The all-time lows in 1921, 1932 and 1982 were
around 0.30, which is about 57% below replacement cost. That's quite a range.

Another Means to an End

Smithers & Co., an investment firm in London, incorporates the Q Ratio in their analysis. In fact, CEO Andrew
Smithers and economist Stephen Wright of the University of London coauthored a book on the Q Ratio, Valuing
Wall Street. They prefer the geometric mean for standardizing the ratio, which has the effect of weighting the
numbers toward the mean. The chart below is adjusted to the geometric mean, which, based on the same data as
the two charts above, is 0.65. This analysis makes the Tech Bubble an even more dramatic outlier at 179% above
the (geometric) mean.

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Extrapolating Q
Unfortunately, the Q Ratio isn't a very timely metric. The Flow of Funds data is over two months old when it's
released, and three months will pass before the next release. To address this problem, I've been making
extrapolations for the more recent months based on changes in the market value of the VTI, the Vanguard Total
Market ETF, which essentially becomes a surrogate for line 32 in the data. The last two Z.1 releases have validated
this approach. Based on the Flow of Funds data, at the end of the third quarter, the Q Ratio was 1.03. The
extrapolated monthly ratios for October, November and December are 1.07, 1.08 and 1.12, respectively (the last
calculated through today's VTI).

Bottom Line: The Message of Q


The mean-adjusted charts above indicate that the market remains significantly overvalued by historical
standards — by about 59% in the arithmetic-adjusted version and 72% in the geometric-adjusted
version. Of course periods of over- and under-valuation can last for many years at a time.

Value Line Arithmetic

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Shiller PE Ratio

S&P Earnings Minus 10 Year treasury Yield

2010: Bulls Make Money, PIIGS Get Slaughtered

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S&P 500 TARGETS

Near Term Support

We see the near term support to be


approximately 1230 on the S&P 500. There is
a possibility the sell off may gain momentum
and find support at the lower end of the band
(see bottom chart) at 1169 but we are
skeptical of this because it is unsupported by
Gann Analysis.

Intermediate Term Top

Our target for an Intermediate top is 1341 on


the S&P 500.

Time Frame

We presently see this Bear Market counter


rally which started in March 2009 ending
2011.45.

This approximates June 13th, 2011

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TrimTabs Reports: No Amount Of QE Will Be Able To Keep The Stock Market Bubble From Bursting

What Source of Money Is Pushing U.S. Stock Prices Higher? Market Cap Rises $2 Trillion in 2010 as
Buying by Companies and Foreigners Offsets Selling by Pension Funds and Retail Investors. However
All of Gain and Then Some, $2.4 Trillion, Since QE2 Announced at End of August.

At the end of 2009, we published a report entitled, ―Are Federal Reserve and U.S. Government Rigging
Stock Market?‖ We questioned whether the Fed or the Treasury were pushing up stock prices because we
could not identify the source of the money that pushed the market cap up by nearly $7 trillion from mid-
March 2009 through December 2009.

At the time we released our report, many people thought it was crazy to suggest that the Fed or the
government would manipulate the stock market. Yet Ben Bernanke, Alan Greenspan, and Brian Sack
have all but admitted publicly this year that the Fed attempts to prop up stock prices.

The market cap of all U.S. stocks increased $2 trillion in 2010. All of the gain and then some, $2.4 trillion,
occurred since the end of August after QE2 was announced. Once again, most of the money to push the
market cap higher does not seem to have come from the traditional players that provided money in the
past

U.S. Stock Market in Trouble Once Fed Interventions Stop. No Amount of Bond Buying Will Keep
Stock Market Bubble from Bursting Eventually.

If the money to boost stock prices by almost $9 trillion from the March 2009 lows did not come from the
traditional players, it had to have come from somewhere else. We believe that place is the Fed. By
funneling trillions of dollars in cash to the primary dealers in exchange for debt, the Fed has given Wall
Street lots of firepower to ramp up the prices of risk assets, including equities.

But what will happen when the Fed stops buying assets? If QE2 works and the wealth effect of higher
asset prices creates a sustainable economic recovery, we think the Fed will stop its QE activities. The Fed
is legally mandated to manage the economy, not the stock market, and we think the Fed will sacrifice the
stock market to its legal mandate. If that happens, stock prices are likely to plunge to well below fair
value.

A more likely outcome is that stock prices will be higher by the time QE2 ends, but economic growth will
not be sustainable without massive government support. Then even more QE will be needed, and stock
prices could keep rising for a while. In our opinion, however, no amount of QE will be able to keep the
current stock market bubble from bursting eventually.

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This chart from Brian Pretti (Don't Tune Out the Commercials)summarizes the current situation as best as any.

What to Watch Carefully

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Tyler Durden at Zero Hedge is raising the warning flags of hidden and somewhat disguised looming increases in
Fed buying which will likely propel the equity markets higher after a brief 'scare' is experienced by the markets.

Here It Comes: US Suspends New Issuance Under Supplementary Financing Program, $200 Billion Liquidity Gusher
Imminent Zero Hedge

Here Comes Another $25 Billion In Excess Weekly Liquidity To Ramp Up Stocks
Frequent readers may recall that 11 months ago, when the economy was falsely rumored to be doing
better, and the Fed was expected to take baby steps in withdrawing liquidity (only to end up having to
inject another $900 billion shortly... and probably much more soon), one of the key mechanisms used was
the Treasury's Supplementary Financing Program, whereby the Treasury would issue 56-Day Cash
Management Bills each week with a $200 billion ceiling. In addition to funding the Treasury with a $200
billion debt ceiling buffer, the program was supposed to extract a fifth of a trillion in liquidity which would
be locked into the rolling of each 56 day bill (each one amounting to $25 billion) up to a total of $200
billion, as disclosed each day in the Treasury's DTS SFP Table 1 open cash balance. Well, not even 11 full
months later, it is now time to unwind the program. The immediate catalyst for the unwind of the SFP is
that the Treasury will most certainly breach the debt ceiling by the end of March unless it gets the benefit
of the $200 billion buffer, which counts toward the total debt issued by the UST. However, what that
also means is that the US stock market is about to become awash with another $25 billion in
suddenly free cash every single week, until the entire $200 billion SFP buffer is depleted. In
other words, take the liquidity impact of POMO, which is roughly $25-30 billion a week, and double it! We
are confident the US Treasury will announce that beginning with the week of February 14, it will no longer
roll maturing 56-Day Cash Management Bills, which means that for the ensuing 8 weeks, one on every
single Thursday, there will be a total of $200 billion in incremental liquidity flooding the market, and
probably sending stocks, commodities, and everything else that is not nailed down into the stratosphere
all over again.

This may be the catalyst for the final leg and the completion of the pattern we have laid out for over a year and a
half now.

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CONCLUSION

1. With the implementation of QE2 and POMO the US Federal Reserve is no longer considered the "Lender of Last
Resort" but rather is now the "Buyer of First Resort". "Extend & Pretend" has been elevated to Systemic
Bubble Blowing with the implementation of these 2 programs which specifically target Fed buying to increase
bond, equity and asset prices.

2. EU Sovereign Debt Contagion is accelerating in Europe and the potential for stealth bank runs from nervous
corporate CFO's and international Finance Committees .

3. Inflation is now emerging and causing problems most clearly in the area of food and energy pricing.

4. Global unrest is gaining momentum and our Tipping Points have been broadened to cover "Social Unrest" and
"Geo-Political Event Risk".

5. Global risk and stability concerns are once again surfacing and being outlined by the IMF, World Bank, World
Economic Forum and others. The causes of the 2008 financial crisis have yet to be addressed.

6. The US Residential Real Estate market has now rolled over and is showing signs of entering a further
corrective leg.

7. Market Analytic and Technical Analysis however indicates that the market still has more to run as we finish this
bear market counter rally by June 2011 with a classic ending diagonal chart pattern.

MEDIA COVERAGE

I encourage you to look through them as they are


listed on the COMMENTARY page of Tipping Points . I
also encourage you to try our new page for real time
Tipping Point news. We continue to make
improvements to the page based on reader feedback.

Gordon T Long
gtlong@comcast.net
Web Page Tipping Points
(http://lcmgroupe.home.comcast.net/Tipping_Points.htm)

Gordon T Long is not a registered advisor and does not give


investment advice. His comments are an expression of opinion
only and should not be construed in any manner whatsoever as
recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he
believes his statements to be true, they always depend on the
reliability of his own credible sources. Of course, he recommends
that you consult with a qualified investment advisor, one licensed
by appropriate regulatory agencies in your legal jurisdiction, before
making any investment decisions, and barring that you are
encouraged to confirm the facts on your own before making
important investment commitments.

© Copyright 2010 Gordon T Long. The information herein was


obtained from sources which Mr. Long believes reliable, but he
does not guarantee its accuracy. None of the information,
advertisements, website links, or any opinions expressed
constitutes a solicitation of the purchase or sale of any securities
or commodities. Please note that Mr. Long may already have
invested or may from time to time invest in securities that are
recommended or otherwise covered on this website. Mr. Long
does not intend to disclose the extent of any current holdings or
future transactions with respect to any particular security. You
should consider this possibility before investing in any security
based upon statements and information contained in any report,
post, comment or suggestions you receive from him.

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