The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The employment picture has turned mixed, which is better than earlier in the year, when things were decidedly negative. For example, nonfarm payrolls fell by 345,000 in May—a large monthly decline, to be sure, but a much smaller one than at any time in the first four months of 2009, when losses were averaging more than 600,000 a month. On the other hand, the unemployment rate surged further, going from 8.9% in April to 9.4% in May—a 26-year high.

We think the mixed employment pattern will continue. Specifically, we expect generally smaller declines in monthly nonfarm payrolls over the next few months and steadily rising unemployment levels, with the latter possibly topping 10% before the end of this year.

The recession is still with us, but its fury is lessening. Not only are there fewer jobs being lost, but we are seeing some stability return to housing and manufacturing— two key sectors that will need to show solid improvement for there to be more than a token business upturn. At this point, the economy is still contracting, but doing so less sharply than earlier in the year, suggesting that the worst of the recession is now behind us.

We expect the nation to be back on the expansion trail by the fourth quarter of 2009. Our sense is that the gross domestic product—which fell by 5.7% in the first quarter of this year—will pare its deficit to 2%, or so, in the now-ending period, flatten out in the third quarter, and increase by 1%-2% during the final three months of 2009. Further modest improvement is likely in 2010, before a vigorous up cycle ensues by 2011 or 2012.

The next challenge for the stock market will be earnings, which may have faltered further in the quarter now ending. We think a notable profit recovery is six months to a year down the road. Investors banking on such a comeback to lift stocks in the second half of 2009 may be disappointed.

Conclusion: The market’s fast and furious ascent since early March and the corresponding rise in long-term interest rates suggest that equities are no longer undervalued. Our Asset Allocation Model— which is based on a quantitative analysis that includes a number of economic and financial factors—has, therefore, turned more cautious. (Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model’s latest reading.) Investors should consider the length of their investment horizon as well as tax considerations in making equity allocations.