The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The housing market remains in a dreadful slump, with no end in sight. In fact, recent construction numbers, in particular those relating to March housing starts and building permits, suggest that the downturn continues to intensify. By way of example, in January of 2006, when the housing cycle was in its ascendancy, some 2.3 million units were started on an annualized basis. In March of this year, that number stood at 947,000. Home sales also are suffering, with sales of previously owned homes off 2% in March from February and down 19.3% from last March. Meanwhile, home prices remain depressed, and both foreclosures and inventories of unsold homes are rising. It is not a pretty picture.

Housing is likely to remain the principal threat to a second-half economic recovery. Clearly, trends in this sector are discouraging, and although we continue to believe that falling mortgage rates and the lower prices now in place will start to whet the appetite of potential buyers at some point, the process could take several quarters, at the minimum. Our forecast of a better second half for the economy is based on the belief that housing will stabilize in the next six to nine months and that oil prices will hold near present levels or ease somewhat. Those assumptions are highly tentative, however.

Other areas are showing some resilience. Specifically, we are seeing continued gains on the export front, a spotty and tentative recovery in industrial production, and generally mixed trends in retailing. So while there is little aggregate strength in the economy, there is also little serious erosion outside of housing.

Meanwhile, the earnings picture is not as bleak as might have been expected. In fact, we have even seen a few pleasant surprises among the industrial and technology providers reporting thus far. As expected, the major casualties are the banks and brokerage houses, where operating losses are common and writeoffs are often necessitated by soured loans.

Investors have been showing their mettle, pushing equity prices up smartly following a sharp selloff early in the year. It would seem that many market participants are looking to a hopefully better second half for the economy and corporate earnings.

Conclusion: We think the evolving market optimism will be vindicated later this year leading to further gains for the stock market. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model’s current reading.