The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The recession that many feared would evolve in the first half of this year failed to take hold, with data for the recently ended second quarter showing that the U.S. gross domestic product increased by 1.9%. This gain followed an initial period that saw GDP rise 0.9%. The better showing in the second quarter came on a jump in export demand and a further modest strengthening in consumer spending. The increase in consumer activity was partially a function of the rebates that had been paid over the past few months. We think the recent positive trends will largely remain in place in the current quarter, when we expect GDP to rise by 1%-2%.

However, it may be just a matter of time before a recession unfolds. In fact, unless we get a second round of fiscal stimulus (including additional rebates), a contraction in business activity could take hold by the fourth quarter and extend into 2009. If a new stimulus package is forthcoming, a recession might be delayed, rather than sidestepped, in our opinion.

Meanwhile, housing continues to be a drag, with the ongoing downturn in this pivotal sector being a major economic depressant. That point was driven home recently by data showing further sluggishness in sales of new homes and existing properties. Home prices also are off and foreclosures are up, as many owners are unable to handle the higher costs that evolve when adjustable-rate mortgages are set at higher levels.

We think a bottom in the housing cycle may be fairly close at hand, though. True, this forecast is rather tentative, but it does reflect recently better news on the inventory front, as new home sales for June suggested that incentives and lower prices are helping to slightly reduce the glut of unsold houses on the market. The balance sheets of certain builders also are showing lower inventories. Should this trend continue a trough in the down cycle might soon take hold.

Investor sentiment continues to wax and wane, in response to shifts in the economic, inflation, and oil price outlook. We think this uneven pattern will be the rule for a while, as the nation traces a path between recession and expansion. Should housing bottom fairly soon, a better economic performance would appear logical to expect by mid-2009.

Conclusion: Even a modest hint of better economic times to come would be warmly received by the market. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model’s current reading.