Economic Indicators / Analysis

Based on the coincident economic indicators, the growth of sales and production saw dwindling
momentum over most of 2011, as the output side of the US economy was slowed by negative
real income and sluggish employment gains. I think it is fair to say that without the benefit of the
2% payroll tax cut, growth would have been marginal at best. Although the payroll tax benefit is
likely to be extended for 2012 after the usual Wash. DC histrionics, it will not be incremental in
force this year. Excluding the tax cut, the real wage rate, measured yr/yr, fell from 0.7% at year
end 2010 to a low of -2% by 8/11. This awful performance has improved since Aug., with the real
wage now running at about -0.8% yr/yr through Jan. The improvement is primarily due to a
significant reduction of inflation momentum which could continue for a few more months. On the
plus side, the yr/yr growth of employment has improved from a scant 0.2% for 8/11 up to a far
more reasonable 1.7% through Jan. So, the underlying buying power of the economy is getting
better, although it is still inherently modest.

In line with somewhat improved buying power, new order rates for US business have improved
markedly since Aug. 2011, and measured by breadth of businesses with rising new order rates,
are solidly positive and suggest a re-acceleration of economic growth in the months ahead.

Measures of global economic activity are also improving in early 2012, but this heavily reflects
the contribution of stronger US new order rates.

The US banking system took a little bit of a holiday over the second half of 2011. With a slowing
economy, banks did not bid agressively for deposits or boost commercial paper outstanding. That
left the Fed as the prime supplier of incremental liquidity over the Aug. '11 - Jan. '12 period.
Perhaps with business now showing a stronger order book and construction spending now
apparently recovering, the banking system will resume providing more liquidity to the economy.

With Europe, Japan and China experiencing growth slowdowns as 2011 progressed, US export
sales have turned modestly lower since the autumn of last year and could continue to be a drag
on the US in coming months.

On balance, with real wages still negative and the banks still reluctant to step up more strongly to
support the economy, the recovery remains fragile on its internal workings, never mind if
problems in Europe take a turn for the worse or if rising mid-east tensions provoke an inflation
shock from a jump in the oil price.

Note, however, that older hands have been buying US stocks over the past several months
because they have watched underlying but modest improvement in economic fundamentals
coupled with a deceleration of inflation pressure.