Stocks have straight-lined higher year-to-date. What’s changed in the key fundamentals driving the market? Here's my summary.

The ECB’s Long Term Repo Operation (LTRO), Europe’s bazooka, has provided the banking system liquidity backstop that was desperately needed to stem a European financial contagion. The LTRO has been the key catalyst for global stock markets’ YTD run higher, and also a turn in the euro currency.

January’s purchasing managers surveys ticked unexpectedly higher in most countries around the globe. Even Europe showed improvement.

Car sales, housing starts, bank lending, personal income, manufacturing and non-manufacturing purchasing managers indexes, index of leading economic indicators— they all posted good gains in January.

The Wall Street Journal found that the 55 economists surveyed in February again bumped higher their consensus GDP growth forecast despite the likelihood of recession in Europe.

The January establishment employment survey showed a healthy +243,000 new jobs created and the pattern of post-recession new job formation is looking pretty good.

What really caught my attention, however, was January’s whopping household employment survey.

Yes, it tends to be much more volatile than the monthly establishment survey but it’s a very positive development nonetheless.

This Wall Street Journal article makes a very important point on which I think we’ll hear much more in coming years. It’s very good news for the U.S. economy. Please read these bullet points.

A key question that I’m hearing more frequently these days is “how much of a jump in gasoline prices would it take to de-rail the recovery?”

My answer: a) economists cannot pinpoint a figure because it depends on a whole array of variables; and b) history suggests it could be a much higher number than is generally assumed.

Why do I say that?

Look at the following chart. Crude oil prices quadrupled from 2002 to 2008 and even then it was the global financial meltdown, not gasoline prices, that put the economy into recession.

But isn’t gasoline a big part of consumers’ budgets?  In fact, less than you might imagine.

The Congressional Budget Office just released its updated ten-year federal deficit and debt projections, an important document given the upcoming elections and yesterday’s release of the Obama Administration’s 2013 budget proposal.

Here is the picture of projected GDP growth, federal outlays and revenues under the CBO’s “baseline” assumptions.

Those projected federal revenues and outlays would result in a cumulative $3.8 trillion 10-year deficit, as you see in this chart.

Notice how it’s assumed in the baseline scenario that tax revenues just keep climbing along with rising spending, as a percent of GDP.

Tax revenues have averaged about 18% of GDP historically. Here they work steadily higher from a base of 20%.

On the other hand, the CBO does a set of projections based on what they term an “alternative fiscal scenario” using, perhaps, a more realistic set of assumptions — such as not allowing the upcoming 30% cut to doctors’ Medicare reimbursement (included in the baseline scenario as scheduled under current law.) These assumptions result in a $10.6 trillion 10-year cumulative deficit.

Point is, leadership is going to have to get serious about making the types of changes to both revenues and spending as proposed by Simpson-Bowles.

On the spending side entitlements are so clearly the problem, growing much faster than the forecast 4.7% trend growth in GDP, as you can see in this chart.

economy keeps growing …” — two big ifs.

However, for stocks to finish 2013 at a level +16% higher than today would not be a stretch if the current earnings forecast comes to pass.

Warren Buffet last week quoted the following remark by a famous Wall Streeter, saying it was apt at present: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.” Renowned professor Jeremy Siegel says “the bond outlook is extraordinarily bad.”

I think it’s very important, here in the aftermath of the once-in-all-time-U.S.-financial-history bull market in bonds, to take heed of these sentiments.

Bond returns going forward aren’t going to be anything like what we’ve gotten accustomed to.

In fixed income, I’d stay short in duration going forward.

Finally, an update on Modern Portfolio Theory. Had you been disciplined in your asset allocation, staying globally diversified and annually rebalancing, according to my calculations this is how it would have looked over the 10 years ending with 2011.

My hunch is that there are very few financial advisors who can claim a 10-year +8.6% compound annual client return.

The main problem in rigorously applying MPT is that it’s boring.

Boring, maybe, but still the best investing mousetrap yet devised.

Professor Craig Israelsen gives us this version of the efficient frontier updated through 2011.

It’s such a powerful illustration of how MPT, rigorously applied, has delivered over +10% annually since 1970 with half the risk of the S&P 500.

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