Stock Market -- Fundamentals

Summary
The stock market has a good shot at returning over 20% in price gain through 2011 provided
the pervasive sense of caution among households, businesses and the banks eases up enough
to allow the economy to function with more normalcy than we have witnessed so far in this
economic recovery. Business will play the most critical role as it must invest, hire and
compensate at more elevated rates if the economy is to recover prosperity. Investors have a
clear sense of skepticism about whether the economy can recover confidence and may not
be easily won over until there are more tangible signs of progress.

Core Indicators
The core group was positive but running out of gas until the Fed announced its new liquidity
injection program (QE '2). Now, the core indicator group will strengthen as the Fed assures
faster growth of monetary liquidity at least through mid  2011.

Secondary Indicators
Measured yr/yr, the growth of the $ value of both production and total business sales is
moderating. With quantitative monetary easing, there will be some acceleration of system
liquidity growth. Thus, the liquidity headwind will continue to moderate as the demands of
the real economy ease, allowing less of a strain on liquidity available to support the stock
market -- a plus.

The inflation adjusted or real oil price is again moving up sharply as financial traders have
jumped into the oil market to "play" QE '2. So far, the rapid recovery in the oil price since
early 2009 has not appeared to have inhibited the stock market.

Profits Growth Momentum
Following the initial recovery surge over late 2009 - mid 2010, profits growth momentum
although substantially positive has been decelerating and is likely to continue to do so
right through 2011. with slower profits growth ahead, investor confidence will become a
much larger factor in determining returns through 2011.

SP 500 Market Tracker (Modeled P/E Ratio X 12 mos. EPS)
My Tracker puts fair value for the "500" at 1370 for 2010 and 1470 for 2011. The SP 500 is
now trading at 1217, or about 11% below fair value for the model. This discount is a
direct and primary result of  investor caution about just how good the earnings outlook is
for the global economy over the next year. In addition, investors continue to prefer smaller
US cap and faster growing foreign economies over the large cap "500", preferences that
have been in force over most of the prior decade.

Fundamental Weekly Coincident Market Indicator
This proprietary indicator advanced an amazing 62% off its deep cyclical low in 3/09 to
its cyclical high to date set 4/30/10 and supported the very rapid advance in the stock market
over the same interval. The indicator fell sharply from 4/30 until early Jul., 2010, and
following a consolidation phase, has been on an upswing since early Sept. So it has moved
in line with the recent rally in stocks and it points to an eventual re-acceleration of economic
growth. However, there is a "hall of mirrors" effect here as regards the indicator and the
stock market. For example, the indicator assigns a heavy weight to a broad basket of
sensitive materials prices such as copper, which, reflecting the financialization of the
commodities market, have mirrored stock price trends. So the unadulterated economic
content counts for less.

Longer Term Economic Indicators
This set of indicators shows there is substantial economic slack and that the economy has
the capacity to expand another 4-5 years easily if it can maintain reasonable balance. The
new round of liquidity injections planned by the Fed strengthens the case substantially
looking out through 2011. However, the indicators do not account for the psychological
states of consumers, businesses and the banks. Additional easing by the Fed provides a
financial framework for caution to abate and for all sectors to loosen up a little more
to realize rather moderate but decent economic potential. It is up to the private sector
now to follow through. The 11% discount of the SP 500 to the Market Tracker reflects
investor caution about just to what degree the economy will return to more normal
operations, with special focus on whether business will unlock and invest and hire
more people back.