I want to take the opportunity and wish you all the best for 2011. To health, happiness and prosperity — especially in risk adjusted terms.

10 From a historical standpoint, the yield on the S&P 500 (2%) is very low. This smacks of a market top and underscores the point that the market is too optimistic; investors are willing to forgo yield because they assume that they will get return via the capital gain. The last time S&P yields were this low was in the summer of 2000, and we know what happened shortly after that.

If there is a positive theme that transcends the weak U.S. economy it’s ag! Farm incomes are way up & indications suggest more increases in ’11. This is due to increasing demand for food, especially proteins, from rising living standards in China, India and other emerging economies. The latest evidence of this was in the Fed’s Beige Book which provided some fine treats to chew on when discussing US food production.

Yields on Greek & Spanish bonds (credit downgrade looms) are up; Irish bond yields are also up to 8.4%, which, in real terms is over 10%. Something is going to give because that is unsustainable when real GDP is CONTRACTING at a 2% rate. In the old days currency devaluation & debt restructuring would have occured by now. And with GDP growth in Germany expected to slow the Euro is clearly not the place to be.

2010 NOV U.S. retail sales up 0.8% but Autos down 0.8%, Furniture/appliances down 0.5%, Electronics down 0.6% & Building materials down 0.1%. What was up? Groceries 0.8% Gas 4.0% Drug stores 0.9% & Clothing 2.7% What we had was a surge in “necessities” which rose 2%, the largest increase since Nov 09. Either there is a seasonal need for more toilet paper, macaroni and fuel in November or the public is feeling poor.

Some economists say higher income taxes keep people from working. This is the substitution effect–because leisure becomes relatively cheaper people consume more of it. But higher taxes also reduce after-tax income so one might work more due to higher taxes. This is the income effect. The question is whether within certain ranges of tax rates, raising taxes increases or reduces effort. Theory gives no clear answer.

The risk of front-loaded fiscal austerity in the UK is that big cuts in spending, subsidies, public employment & increases in taxes will have a recessionary effect on an anemically recovering economy. A credible early commitment to gradual fiscal consolidation phased in in a back-loaded manner would have reduced the risk of a double-dip while maintaining the authorities’ commitment to credible fiscal consolidation.