The document provides a quarterly analysis of market conditions from a senior analyst. It finds that while technical indicators are moderately bullish, sentiment has shifted to pessimism after the market correction. Liquidity remains sufficient due to central bank intervention, but credit growth is modest and not very productive. The fundamentals are concerning as economic reports have disappointed and earnings warnings have increased, suggesting growth needs to pick up in the second half for a positive outlook.

1. MarketView Analyst Report
3rd Quarter 2012 July 19, 2012 Frank P. Corbett, Senior Analyst
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ITS-BDR-3-134-20120719For Professional Use Only — Not For UseWith the General Public
Technical
• The S&P 500 stock index corrected 10% from April to early June after a six month rally to a post-recovery high;
Key secondary indexes such as small caps, transports, and cyclical stocks did not confirm the April new high in
the cyclical bull market
• The correction relieved some very overbought conditions as the market found support; a period of
consolidation could set the stage for a risk-on rally in the second half
• On balance, technical indicators are moderately bullish
Liquidity
• Stress indicators, such as bond spreads, have improved in the last month
• Credit is growing at a modest pace and has reversed the 2008-2009 contraction; Efficiency of the new
debt is uncertain
• Central banks stand ready to supply additional liquidity if needed; the US Federal Reserve is likely to implement
QE3, particularly if difficulties are encountered
• Net, liquidity is sufficient
Sentiment
• Bullish sentiment of April has succumbed to the market correction and pessimism now prevails; it could mount
for a while but eventually help set the stage for a rally
• Turning Bullish
Fundamental
• Most economists are calling for 2% GDP growth for 2012 and analysts peg S&P 500 earnings growth at 8%
• Economic reports of late have disappointed and a number of large corporations have issued earnings warnings
based on slowing global growth
• Momentum seems to be deteriorating; Growth will need to pick up in the second half; Caution is warranted on the
fundamental front
********************** Indicator Summary *********************
The S&P 500 reached a new post-2009 recovery high in April. The NASDAQ reached an 11-year high. Some supporting measures, like the
cumulative Advance/Decline line, have confirmed the move.
Non-confirmation was seen in other key indexes like small cap stocks (Russell 2000), cyclicals, and transports. They failed to make new
post-2009 highs. Likewise, the number of individual stocks making 52-week highs was unimpressive. The peak of new highs of NYSE stocks
was 7% during the October to April rally. By comparison, about 28% of NYSE stocks made new highs in November-December, 2010, the
best of the post-2009 bull market. It would be more constructive if lots of individual stocks were accompanying the indexes to new highs.
Put another way, fewer soldiers have followed the generals on each march. In addition, volume during the October-April rally was anemic.
Technical

2. ITS MarketView Analyst Report Page 2
ITS MarketView Analyst Report, July 19, 2012
Of particular interest in the chart is the RSI (Relative
Strength Index) displayed on top of the S&P 500 stock
index. It broke above 70 in the first two rallies of this
cyclical bull market. It topped out near 68 on the rally
ending this past April and promptly rolled over. That’s a tip-
off the rally lacked the“power”of the prior two.
We noted last quarter:“On at least a temporary basis, the
market is overbought and due for a pause or correction.”
The market has pulled back and some of the overbought
conditions have ameliorated. The S&P 500 is attempting to
stabilize around 1300, which is fairly decent support.
Having noted some negative technical aspects, the April
to early June price action of the general market looks like
a normal correction within an aging cyclical bull market.
(The rally since March, 2009 has run 44 months compared
to the average 19 months for cyclical bull markets within
secular bears. It’s the second longest such rally since 1900).
Some indicators on weekly charts such as BollingerBands
and MACD give clues the market may rally or at least
stabilize. For now, the bull should be given the benefit
of the doubt. As time goes on, more technical“negative
divergences”would be a potential reason to become more
bearish. For now, holding or adding modestly to areas of
opportunity is reasonable.
Stock market tops are usually marked by declining liquidity. Indicators of declining liquidity include Fed tightening, low credit creation,
declines in the money supply, an inverted yield curve, rising spreads on risky bonds, and falling commodity prices. Historically, not every
one of these conditions needs to occur, but several generally have transpired as markets encounter difficulty.
A conspicuous concern is the spreads and CDS on peripheral European sovereign debt such as Italy and Spain. They remain at elevated levels
and should be observed closely. Europe is conceivably the one event that could cause rapid market deterioration.
Governments and central banks are of course monitoring circumstances and have repetitively intervened with QE, bailouts, LTRO, etc. to
re-liquefy the system. Don’t expect to see a systemic event or recession without governments throwing everything they have at it.
What about the Fed? A new round of Quantitative Easing (QE) seems to be the option most likely to drive markets. Under QE, the Fed buys
bonds and pays for them with newly created cash, injecting it directly into the system. QE3 has a number of potential triggers. First, GDP
growth could slip to the negative side. Or inflation prints a low or negative number. A marked rise in unemployement would be of
Liquidity

3. ITS MarketView Analyst Report Page 3
ITS MarketView Analyst Report, July 19, 2012
concern, given the dual mandate. A shock, possibly from Europe, could set more QE in motion. Some cynics claim a 15 to 20% decline in
stocks would by itself bring the Fed in.
Is QE a cure-all? Several legitimate issues need to be raised. One, the lag before action is taken and the effects pass to the economy
or markets may be such that damage may have already occurred. Second, the benefits of QE to the real economy may be minimal and
diminishing. Third, the effective staying power of these measures seems to ebbing but the effects (on stocks and commodities) can be
powerful for a time.
Credit creation is playing a role in maintaining liquidity. Commercial loans and leases, Federal government debt, and student loans are
growing. Unfortunately, the latter two sources of credit growth are not efficient in terms of additional GDP per dollar of debt. Total credit
market debt outstanding, while now above 2007 levels, is growing at a modest annual rate of 2.5%. By comparison, credit grew about 10%
yearly from 2000 to 2008. Some observers, such as economist Richard Duncan, feel credit growth of 2% or less is insufficient to keep the
economy above water. In summary, credit is growing but not productively and barely sufficiently.
Liquidity gauges in general for now demonstrate
sufficiently accommodative financial conditions.
For example, high yield bond spreads have been
well behaved after last summer’s upsurge. Lower
quality issues often react first in advance of a
withering economy so the spreads on high yield
bonds overTreasuries are always of interest.
On the whole, liquidity overall has slightly
improved from last quarter, citing the Bloomberg
Financial Conditions Index. The St. Louis Fed Stress
Index is also trending tolerably. (Both measures
are composites of various market indicators; they
moved up during May and have since recovered).
Sentiment is a tool we us a contrarian indicator. Extremely pessimistic or exuberant outlooks on the market habitually, sooner or later,
result in the market moving the other way. Last quarter, this report stated:“These indicators have shifted to a positive outlook on the
market…On balance it has been historically difficult for the market to mount a major rally, say 15% or greater, from sentiment levels like
this.” So, sentiment said to not jump head-long into the market.
Sentiment has now shifted to the glum side. NedDavisResearch stated on June 16:“Sentiment has not gotten quite as pessimistic as in
2010 and 2011, but is pessimistic enough to support a bottoming process.”
In addition to polls, indicators involving a monetary commitment by investors are valuable. The short interest on the NYSE is approaching
all-time highs. The level of puts on individual equities remains elevated. On June 6th the 21-day average put/call ratio nearly reached the
same level as last summer’s crisis levels.
Sentiment

4. ITS MarketView Analyst Report Page 4
ITS MarketView Analyst Report, July 19, 2012
45.0
50.0
55.0
60.0
65.0
70.0
75.0
80.0
85.0
90.0
95.0
650
750
850
950
1050
1150
1250
1350
1450
1550
5/23/06
11/23/06
5/23/07
11/23/07
5/23/08
11/23/08
5/23/09
11/23/09
5/23/10
11/23/10
5/23/11
11/23/11
5/23/12
S&P500 Equity Put/Call 21d ma
Source: CBOE & Dial Data
On the assumption investors have acted on their beliefs by selling, shorting or hedging with put options, some of the downside risk has
been alleviated. Markets could fall more and pessimism could mount, but some of the air has been let out of the sentiment balloon.
The U.S. economy grew 1.7% in 2011, on the heels of 2010’s 3% growth. Surveys of economist’s estimates for 2012 are centered on 2%.
Few economists appearing in the financial news, except for ECRI, David Rosenberg, and John Hussman are calling for a recession. Not one
of 49 economists in the WSJ July survey is predicting a recession for 2012, with a low estimate of 1% and a mean of 2%. The 2012 average
estimate has dropped from 2.5% in April, perhaps as a result of recent data.
Earnings for the S&P 500 companies are expected to increase 8.4% in 2012. 2nd quarter earnings are expected to increase 3.3% year over
year. Most of the year’s boost is anticipated to come in Q4, with a 14.7% y-o-y jump (Source:FactSet). It will be a challenge. Companies
such as FedEx, Bed, Bath & Beyond, Proctor and Gamble, McDonald’s, Ryder Systems, and Adobe have lowered guidance recently.
Recent economic reports continue to lose steam. Some are moving in a disquieting trend. The June Philadelphia Fed General Activity Index
dropped substantially to minus 16.6, the lowest reading since August 2011. (The survey covers manufacturing activity in parts of several
Mid-Atlantic states). The ISM Manufacturing Index fell below 50 in June, indicating contraction in the manufacturing sector. Jobs growth
has slowed in recent months. Retail sales fell in June for the third straight month. The Citigroup Economic Surprise Index, which measures
how much reports are missing or beating the median estimates in Bloomberg surveys, was at a 10-month low in June.
Fundamentals

5. ITS MarketView Analyst Report Page 5
ITS MarketView Analyst Report, July 19, 2012
One driver of higher bottom line earnings is expected
to come from expanding margins. US corporate profit
margins before taxes are just below the all-time high
of 14.63%. The consensus forecast is for net profit
margins to keep rising, according to GoldmanSachs.
The firm’s equity strategist, David Kostin, takes a
different view and expects margins to decline. That
would be in line with the historical norm—they have
never been sustainable in the past.
Many strategists have expressed concern about the
expiration of tax cuts and mandated automatic cuts
in government spending. Instead of the dreaded
“fiscal cliff,”additional stimulative measures and
higher budget deficits may well prevail in the US and
elsewhere under the new-found cover of“growth”
policies.
In summing up the fundamental
side, expect slow growth in the U.S.
A lot will have to go right for the 8%
earnings growth to materialize. In
particular, a currently fatigued US
consumer will need to find a fresh
burst of energy as the year progresses.
China and Europe will have to avoid
dispensing downside shocks. When
all’s said and done, if a recession can
be avoided in the US, a major market
decline should be evaded as well.
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
1950-I
1953-I
1956-I
1959-I
1962-I
1965-I
1968-I
1971-I
1974-I
1977-I
1980-I
1983-I
1986-I
1989-I
1992-I
1995-I
1998-I
2001-I
2004-I
2007-I
2010-I
Corporate Profits (blue), Recessions (gray), and Market Peaks (yellow)
Sources: NBER, BEA
Market Scenarios
Prior proposed scenarios for the 2nd Quarter 2012, offered in April 2012:
• BaseCase: The market is overbought and due for a pause. Sentiment and seasonal factors also suggest a pause or more likely a correction
of 5 to 10 percent. This would be healthy for the market. Nothing grows to the sky and if the market were to advance further, it could set up
a more serious correction or an elongated consolidation. The bulk of our indicators are nonetheless not bearish long-term. So look for the
market to stall in the 1400 area with some downside action—60% probability.

6. ITS MarketView Analyst Report Page 6
ITS MarketView Analyst Report, July 19, 2012
• BullCase: Momentum is strong, there is sideline money waiting to come in and liquidity is positive. Central banks will probably move to
add more liquidity if needed. A further large advance is unrealistic now but a modest gain of 3 to 4 percent is plausible for Q2. That would
place the S&P 500 in the 1450 zone—20% probability.
• BearCase: The waterfall decline of last summer was the first shot over the bow of the post-2009 cyclical bull market. Spreads and stress
indicators exploded. The rally since then is a classic“throwback”rally that was extended by massive liquidity. Liquidity will do little in this
case to drive growth or heal over-leveraged economies. Markets are putting in a long-term top and will not advance much further—20%
probability.
Outcome: TheBaseCasewonoutlastquarterasthemarketstalled.
Scenarios for the 3rd Quarter 2012
• BaseCase: The market is undergoing a corrective/consolidation phase. The market is held down by anemic economic and earnings
reports, at least in the near term. Conversely, the market is also sustained by hopes for 4th quarter growth and for more QE. Both of these
divergent influences will likely carry on through the rest of the summer, with neither coming out on top. Look for a choppy 3rd quarter with
the S&P 500 fluctuating within a range of 1250 to 1400—50% probability.
• BullCase: The market will be supported by modest economic growth. Record S&P 500 earnings of $104 this year and then $117 next year
are expected. Lower fuel prices will spur the consumer. Auto sales are strong. Housing is coming back. Low rates will force investors out
of bonds into stocks. Lots of cash is in money market funds earning nothing. Congress will likely extend most of the tax cuts and spending
programs. Central banks will move to add more liquidity if needed. Europe will find a way to fix its problems by early next year. China is
likely to stimulate. The market will anticipate future developments and move to a new post-2009 high above 1422 this quarter—20%
probability.
• BearCase: The waterfall decline of last summer was the first shot over the bow of the post-2009 cyclical bull market. The rally since
then is a classic“throwback”rally that was extended by massive liquidity. Liquidity will do little in this case to drive growth or heal over-
leveraged economies. The bear case is upped by 10% from last quarter due to the following factors: Company earnings warnings are
escalating, economic reports are dour, and there is no easy fix for Europe. The high for post-2009 rally has been put in—30% probability.

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