A year ago our economy was in deep trouble.  Poor economic reports headlined the news weekly and, after
the Lehman collapse, shocked the stock market into a continuous steep decline
into early March of this year.  Now
that the stock market has performed well in both the second and third quarters
people are once again actually reading their investment statements before
filing them.  Though stock market gains
are making individuals’ feel wealthier, confidence remains low, which is to be
expected given that our nascent economic recovery is a jobless one.

I believe our economy is on track for a recovery in the fourth
quarter. Housing starts and prices are beginning to bottom out. Consumers are saving
again and cleaning their balance sheets, companies are lean and primed for
rebuilding inventories, trade balances with emerging markets are improving, and
the bulk of the federal stimulus money will probably be spent in the fourth
quarter of 2009 and first quarter of 2010.

There are risks that could delay a recovery. If long-term interest rates
rise, that would impede a housing recovery and restrain business investment
spending. If consumers turn more pessimistic they could overdo their savings
and suppress a recovery in consumer spending.

But on balance it appears that the climate has improved and the pieces
are in place for a recovery.

Housing prices are still falling but the decline is
finally slowing down. Rising sales volumes in many markets, including Los
Angeles, Las Vegas, Phoenix, and Miami, indicate that markets are clearing inventory
and housing prices are approaching cyclical lows. Prices are still 12 percent
lower than last year but clearly an improvement from the 20 percent year over
year declines we saw earlier in 2009.

New construction remains depressed, but early signs of
stabilization are evident. Two previously negative forces, rising mortgage
rates and increasing energy prices, have stalled in the last few months. The
longer these two potential negatives remain range bound, the more time this
recovery can mature and gain strength.

Americans are saving again! The lavish spending binge brought on by
easy credit and low interest rates is drawing to a close. The hangover will
stay with us for some time, but at least the party is over. It is a normal
corrective process that occurs in virtually all recessions for households to
cut spending and replenish savings.  Historically, the US household savings rate has averaged 7
percent of income. During the economic boom of 2003-2007, it dropped close to 0
percent. We are back to 5 percent levels now and I anticipate it rising to 7
percent in 2010.

Corporate earnings outperformed in the first and second
quarters largely from cost cutting. 
Most of the cost cutting is over and companies are as lean and mean as
they can get.

If the United States economic recovery occurs slower than we anticipate,
we are hopeful that emerging economies such as China, India, and others, will
be an engine of growth for us. Emerging world consumption has grown more than
twice as fast as United States consumption. Plus, this new consumer force is
much younger than our population and holds much less debt.

How Will
The Stock Market Fare?

Though we may have weathered the storm of the last 18 months, our
economy is weakened and still fragile. 
The stock market will exaggerate its reactions to economic reports as it
tries to answer the question “is it safe?”.  Investors who have benefited from the recent gains wonder if
it is time to get back to the sidelines and investors who have been on the
sidelines wonder if they should finally participate.

No one knows how far the market will go before it takes a breather. It
is important to remain flexible to change and keep portfolios sufficiently liquid
to take advantage of opportunities in the stock market. My best guess, though,
is that the stock market has more room to run from here. I believe companies
will show better than expected growth in coming quarters and sidelined money
will come into the market and further support stock momentum. Yields on money
market funds and bond investments are sufficiently low to compel investors to
take on some risk in the stock market. Additionally, relative to bond yields,
stock dividend yields are at historically high levels. With careful
stock choices, the stock market may indeed finally “be safe.”