The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The consumer remains relatively cautious. This wary outlook can be seen in dismal sales during March at retailers Kohl’s, J.C. Penney, and Nordstrom. Indeed, only discount chains Costco and Wal-Mart saw any significant strength last month. This hesitance by consumers can also be seen in lackluster sales of furniture, electronics, and building materials, as well as in eroding sentiment data. In fact, both the Conference Board and the University of Michigan reported sharp declines in confidence recently. The combination of uninspiring sales and eroding confidence now suggests that the consumer sector—which has absorbed a good deal of punishment in recent months— is in a recession.

The country is now probably in a recession overall, as the industrial side of the economy is exhibiting little aggregate strength either. In fact, the lone area of continuing improvement is the export market, where volume is increasing moderately. Such selective strength, however, is unlikely to be sufficient to keep the economy from falling into at least a mild downturn in the current half.

Our sense is that a selective business recovery will be forged in the second half. That upbeat view assumes that the series of interest rate cuts made by the U.S. Federal Reserve since last summer and the stimulus program enacted earlier this year will gradually put a floor under the ailing consumer sector, including the deeply troubled housing market, which is continuing to weaken. At best, we think U.S. gross domestic product growth will average 1%-2% until the second half of 2009.

Meanwhile, earnings are likely to come under pressure this year, due to a combination of slowing economic activity and higher costs, notably for oil and commodities. Unless we see a pickup in selling prices to offset these increased costs, profit margins will tighten and earnings will suffer. The profit picture should brighten later this year as the economy slowly recovers.

Earnings are under pressure, in many cases, with the long-suffering housing and financial sectors being two of the principal profit laggards. Results in the high-tech and industrial lines are generally mixed. We think results will pick up a bit after midyear.

Investors are taking much of this in stride. To be sure, stocks have fallen when high-profile companies, such as General Electric, have shown disappointing results, but rallied on betterthan- expected news. For the most part, the market is proving quite resilient, following a weak start to the year. This better performance is an expression of confidence that the economy will firm up later in 2008.

Conclusion: We think patience will be rewarded this year, although the path to those higher stock prices may be quite bumpy. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model’s current reading.