Abigail F. Doolittle | abigail@peaktheories.

com

November 12, 2010

The Weekly Peak

In Praise of Bernanke’s Fed and QE2
I have a smile on my face right now. I clearly lack the proper qualifications and edifications to take on the titled task but nonetheless I shall attempt
to do so in my own way.

First, Fed Chairman Ben Bernanke is to be applauded for being a decisive leader who has been able to act on his apparently deep academic
knowledge around financial and monetary crisis. While it is easy to accuse him of dropping dollars from the sky or acting outside of the Fed’s
bounds, the ultimate outcome of his unusually active brand of monetary policy is unknown at this time.

What is more known, however, is that had Mr. Bernanke not acted so aggressively in 2008 and 2009, it seems rather certain that the financial
system would have fallen off of the top of its debt mountain and its partial or complete collapse would have brought about a severe depression.

Had a more timid person been at the helm of the Fed at that time, there is a chance that we would still be suffering from that depression today.

Surely the person who guided us away from that most frightening cliff has the sense to continue steering us away from the edge even if the
methodology is unconventional and disputed by many and even if we end up falling eventually. To state the obvious but perhaps overlooked, until
we’ve fallen, we have not fallen and this is something we should not take for granted, in my view.

Second, the entire Board of Governors of the Federal Reserve System is to be applauded for acting as a team under Mr. Bernanke’s guidance in
such uncertain times. I continue to believe that the dissenting opinions of the various officials are dropped in an artfully timed manner that speaks
to a highly strategic and coordinated effort.

It is in this dissent that the Fed is able to gauge the reaction of global leaders and investors to its potential actions while leading them to its
decided-upon strategy slowly but surely. Also in this dissent is the Fed’s telegraphed ability to shift course subtly or dramatically by simply
emphasizing one opinion over the others until it becomes the new strategy.

This flexibility is genius in a way because the Fed is never truly tied to one brand of monetary policy and while this reflects the structure of the Fed
itself, Mr. Bernanke’s Fed in particular seems to be stretching it successfully to its fullest capacity.

All of this stretching, however, comes with the safety net of Mr. Bernanke’s aggressive stance toward both monetary policy action and, as we have
all learned rather recently, communication.

And this brings us to QE2. It may come wrapped in the package of $600 billion, but QE2 is about psychology.

The heart of the problem or the disappointing pace of the economic recovery is slow-moving money and even a possible liquidity trap. The latter is
a situation in which the central bank by definition can do little to stimulate the economy since rates are near zero and additional liquidity will only
add to the existing swamp.

As I’ve been writing since March, the Federal Reserve is painfully aware of this situation. As I wrote in August, the Fed acknowledged this
awareness on August 10 in admitting there’s a problem – “the pace of recovery in output and employment [had] slowed in recent months” – and in
more tacitly admitting there’s little to nothing that the Fed can do about it by making a token gesture to reinvest the principal payments from its
existing portfolio of agency and agency mortgage-backed securities.

The traditional weapon of choice or lowering the federal funds rate was out. Pumping excessive liquidity into the system would more surely bring
about a liquidity trap and a swamp of slow-moving money. Lowering the rate paid on excess bank reserves would target the slow-moving money
issue most directly by potentially providing banks with an incentive to lend but incentive does not equal the thing itself and especially in the face of
a poor demand picture.

The only remaining option that I saw back in August was good old-fashioned jawboning. In other words, the Fed’s only real weapon to help
stimulate the weak economy was psychology.

If the Fed could somehow create an overall improved confidence in the economy, it may have a shot at getting money and credit moving again
such that some of that slack would be eaten up while spurring spending, and, if all of the stars aligned, somehow help with abysmal private sector
hiring and a very weak overall employment picture.
 Peak Theories Research LLC 2
The Weekly Peak

Well, Mr. Bernanke chose something much better than jawboning. He chose its uptown cousin called communication.

And he did so well before August by setting the stage in late July in talking about the “unusually uncertain” times and then reinforcing that view
with the aforementioned downbeat assessment from the August FOMC meeting. In so doing, Mr. Bernanke provided himself with a bottom to
launch from on the spring of another potential round of quantitative easing or what was dubbed QE2.

Specifically, Mr. Bernanke said, “Should further action prove necessary, policy options are available to provide additional stimulus.”

Remembering the rather positive effect QE1 had on the stock indices and commodities in 2009, investors started to play opposite Mr. Bernanke’s
bluff by bidding up stocks and commodities on the back of an implicitly-Fed supported decline in the dollar. Investors did this while looking past
the fact that such money-pumping was unlikely to do little to stimulate the economy itself while also looking past the fact that QE2 was not a
definite and if it did occur, its specifics were unknown.

However, it was the Fed’s September 21 statement and its pledge “to provide additional accommodation if needed to support the economic
recovery” that moved investors into full rally mode.

Without spending a penny or committing to a particular plan around another round of quantitative easing, Mr. Bernanke’s communication caused
double-digit percentage gains in stocks, gold, silver, and oil along with many other commodities between his August speech and the actual
announcement of QE2 on November 3.

Not bad for three words and behind it Mr. Bernanke’s mastery of psychology and with it a psychology of wealth and confidence and the
psychology required to get the economy moving more quickly again.

In addition, Treasury yields moved to early 2009- and, in some cases, record-low levels by early October when by mid-October the price of these
securities started to fluctuate and even decline as judged by the 10-year’s yield moving above 2.70% from below 2.40% before the November 3
QE2 announcement. And this brings us to an interesting point.

While one of the goals of QE2 is to lower borrowing rates, the mere anticipation of QE2 caused yields and thus rates to drop to absurdly low levels.
This goal, then, was achieved pre-QE2.

As I wrote yesterday and while I don’t have the math to back it up, it seems to me that there’s little absurdly low rates will do to stimulate
borrowing activity in a weak economic environment beyond what historically low rates might do. And so, if the 10-year’s yield moves up from its
current 2.65% to say 3.0% or even 3.25% on the relatively benign inflation risk introduced by the monetary part of QE2, borrowing rates will move
up slightly but will remain historically low while the Fed may succeed in moving away from disinflation and avoiding deflation.

And so it seems that everything Mr. Bernanke could have hoped to have achieved by actually buying Treasury securities was achieved by simply
communicating its possibility. The Fed planted the QE2 seed and investors did the rest.

Rates are down with room to move up modestly while still remaining low, the stock market and other risk assets have been bid up creating a sense
of prosperity, and the dollar’s decline may help with U.S. exports while introducing a touch of real world inflation through more expensive imports.

The critics of QE2 are many though with the critiques ranging from currency manipulation to asset bubble promotion here and abroad to moral
hazard to runaway inflation to skepticism over the wealth effect.

While each of these points is valid, I think QE2’s many critics miss what I have been writing about here or psychology.

Trying to determine the exact effect of the stock market’s rise or even QE2 itself on GDP is interesting but stoking life into an economy on the brink
through monetary policy is as much about art as it is science. When traditional policy is no longer an option, I think it becomes a matter of
creating the aforementioned psychology of wealth and confidence to induce, potentially, increased corporate and consumer spending. It is about
creating an environment of certainty in which both corporations and consumers are going to be willing to borrow and spend while banks will be
willing to lend.

Such a sensibility cannot be captured by math and without it, the economic recovery cannot be supported nor can price stability be sustained.

In other words, this is about restoring complete confidence to a system that was shaken to its core by the worst financial crisis in a century and
in the face of fiscal paralysis.

While it’s unknown how such confidence is re-established or how long it takes, it seems that Mr. Bernanke has been successful in reigniting this
sort of a psychology and one that may have a chance of becoming a self-fulfilling prophecy if the spark truly takes hold.

November 12, 2010

Please see important disclosure statements at the end of this document. www.peaktheories.com
 Peak Theories Research LLC 3
The Weekly Peak

It is that or the stoking and maintaining of such a sensibility that QE2 must now achieve. In turn, it may spur bank lending, corporate and consumer
spending, price stability, and, in almost non-causal fashion, hiring. That its actual mechanisms provide for complete flexibility of action by the Fed
to find the exact balance between what are objectively non-excessive liquidity injections and communication is not only clever but is likely to help
keep this newly relit fire going for at least a little longer.

The real challenge, however, is keeping it lit so that it won’t get blown out when the next iteration of the world’s 30-year borrowing binge likely
comes back to make another visit. Irrespective of the result of that seemingly impossible fight though, I think Mr. Bernanke and his team are to be
praised for doing everything that is sensible to support the economic recovery today.

Sam’s Stash, Gold, and the S&P

Briefly on Treasurys after writing on the topic in a rather disjointed manner yesterday, I think Treasury yields will move up modestly in the near-
term as prices decline and in the face of the Fed’s upcoming buying of these securities. As was implied above, I think the Fed will not be against
such a movement since rates will still be low while with a lining of a slightly higher expectation for inflation.

I believe this sort of upward movement in yields will come as a result of: (1) an unwinding of the “invest in what the government’s investing in”
trade with current yields offering investors virtually nothing, (2) the precedent of QE1 would suggest yields are likely to move up on the prospect of
potential inflation risk, and, (3) rational investors are unlikely to remain in securities that offer no real return for long.

Turning to the dollar, I continue to believe that the dollar index will move lower than last week’s 75.63 before moving significantly lower or
potentially higher.

My belief is based on the confirmed Descending Triangle in which the dollar index is caught and this particular pattern carries a target of about 71.

Something else is going on here, however, and it’s the something that prompted me to write on the dollar index on Tuesday and that appendage to
the right of the chart only it’s not the Rising Wedge I thought it might have become. Rather, I believe it may be a bearish pattern that will cause
some of you to laugh – at me – but rather than reveal its name today, I’d like to watch it develop another day or two.

Its target is about 73 and found around the support/resistance band put in between April and July 2008.

Looking at the precious metals, I don’t have anything to say as is usual since I simply watch in awe as gold and silver simply trade up.

November 12, 2010

Please see important disclosure statements at the end of this document. www.peaktheories.com
 Peak Theories Research LLC 4
The Weekly Peak

The one thing I will say, however, is that silver’s chart is nearly sickening and so I’m going to do take a stronger look at it this weekend and get back
to you this coming week on what I might see.

And lastly, let’s turn to the S&P 500.

Thankfully, the weekly 2-year chart continues to look good because the daily 1-year looks almost awful to me while the daily 6-month (not shown)
looks fine.

What accounts for the discrepancy between the 1-year and the other two charts is something I don’t know, but I’m willing to bet it tells us whether
the index’s Uptrend continues or not.

It certainly seems that the S&P 500 is fighting to do so considering that the index just closed above Tuesday’s close yesterday in a truly gritty move.

Frankly, I think the index is adjusting to the fast “growing pains” of last week’s Runaway Day made on Thursday. While the volume has been
meager in relation to the volume seen late last week, it’s remained in a consistent range despite the volatility and this strikes me as being more
favorable to volatile volume. However, it is not the strong volume required to rule out the possibility of last week having been a bull trap.

On the other hand, the fact that the S&P 500 touched 1,204.33 on Wednesday and held that level today in moving off of 1,204.49 seems to be a
positive.

But while the S&P 500 has closed up from the “mandatory” level of Tuesday’s close of 1,213.4 each day since – by a hair – its trading action has
been all over the place and this strikes me as not such a positive. The clear negative would be the one I’ve been writing about this week or if the
S&P 500 were to break 1,198 and the truly negative would be if it were to close below that level.

However, and despite all of this volatility which is likely to bear some more of the same, the S&P continues to demonstrate an Uptrend and one
that is a Continuation of the cyclical bull market born in March 2009.

Until this trend is shown to have been reversed beyond a doubt, it remains in place and for this reason, among a few others, I reiterate my near-
term tactical target for the S&P 500 of 1,300 within my long-term secular view that the S&P will decline to 425.

S&P Targets and Qualitative Views for Various Time Periods November 12, 2010

3 to 6 Months 1,300 Constructive

6 to 36 Months TBD TBD
36 Months+ 425 Bearish

As always, thank you for taking the time to read this week’s piece.

November 12, 2010

Please see important disclosure statements at the end of this document. www.peaktheories.com
 Peak Theories Research LLC 5
The Weekly Peak

DISCLAIMER

Opinions expressed herein are strictly that of the author and are subject to change without notice and may differ or be
contrary to the opinions or recommendations of any professional associations held by the author including the author’s
employer. The opinions contained herein should not be taken as specific recommendations to be acted upon. Any prices
or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given
price. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness,
reliability or appropriateness of the information, methodology and any derived price contained within this material. The
securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain
categories of investors. The author may have or have had interests long or short positions in the securities or related
financial instruments referred to herein, and may at any time make purchase and/or sales in them. Neither the author or
any person or entity related to the author nor the author’s professional associations, including the author’s employer,
accept any liability for any loss or damage arising out of the use of all or any part of these materials.

November 12, 2010

Please see important disclosure statements at the end of this document. www.peaktheories.com