Something really new?
Use a new optical mouse ($15), it can sense the minimum movement of the
shaft rotation and can delivery it to you via RS232...
You need to ensure that no oil or grease will blind the CCD sensor.  The
shaft body should be within milimeters of the mouse.
This solution is cheap and requires no modification or installation of
anything at the shaft, just the mouse.
The CCD captures several images per second and account on image difference
to report the XY movement.

W46NER

--
http://www.piclist.com hint: The PICList is archived three different
ways.  See http://www.piclist.com/#archives for details.