The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

A severe recession is probably in place. Evidence of this downturn in economic activity is provided by data showing falling industrial production, weak retail sales, plunging consumer confidence, and the continuation of one of the worst housing setbacks in years. Tight credit conditions (which are making it difficult for businesses and many individuals to obtain loans) and the report of a decline of 0.3% in the nation’s gross domestic product in the third quarter are also consistent with a recession. The fragile state of the economy is underscored further by the Federal Reserve’s vote (on October 29th) to lower interest rates by one-half a percentage point (going from 1.50% to 1.00% on the federal funds rate) for a second time this fall.

We think the deterioration in U.S. business activity will last several quarters. In fact, should GDP show a decline of 2%, or so, in the fourth quarter, as we now expect, the nation would—by virtue of back-to-back quarters of falling GDP— be officially in a recession. Our sense is that GDP will contract further during the first quarter of 2009, and might well be flat or ease slightly in next year’s second quarter, thus producing a recession of as much as a year in duration. We think a sluggish recovery will follow initially before somewhat faster GDP growth returns in 2010 led, perhaps, by a gradual revival in housing.

Earnings will be a major casualty of the current economic woes. Not only have third-quarter earnings been disappointing in many instances, but the outlook for the fourth quarter of 2008 and for 2009 have now gotten worse. Our sense is that it will be 2010 before we see a broad profit recovery. That prospect has no doubt been weighing heavily on the stock market.

International weakness is also apparent. Recessions are now likely across much of Europe and parts of Asia. Additional reductions in interest rates are likely on the world stage in an effort to lessen the severity of the probable global business downturn.

Investors have shown little faith. Stocks have been falling for weeks on both sides of the Atlantic as well as across Asia—with only brief rallies in between—as the world faces the most serious economic problems in years. Fear and uncertainty, it would appear, hold much of the world in their grip.

Conclusion: It takes courage to buy stocks at such times, but for patient, venturesome investors, it might prove to be the time for such courage. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model’s current reading.