The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The economy remains a good news, bad news story. Clearly, the business outlook is improving. In fact, much of the data- covering a range of consumer and industrial sectors-now affirm that the recession ended in the second quarter and an upturn began over the summer. What is less clear is the strength of that revival, as most reports being issued are consistent only in being inconsistent. Here is a rundown:

Retailing: The nation's retail chains posted modest sales growth in September, led by Kohl's and Target, while old-line chains, such as Macy's and J.C. Penney, suffered declines. Overall, sales rose 0.5% last month (if we back out the volatile auto sales component), a smaller increase than the 1.0% rise tallied in August-again after backing out autos. These gains were insufficient, in our view, to give us confidence that the holiday season will be memorable in a positive way.

Housing: Here, too, the news is somewhat encouraging. However, the recovery has been selective and focused mainly on rising volume. Pricing continues to be weak, by comparison, and may not recover meaningfully for a while, especially since the damage done to 401k's and other retirement accounts, where many potential downpayments were lost, was so extensive.

Employment: Payrolls fell further during the summer, albeit at a lesser rate than earlier in 2009, while the unemployment rate rose to 9.8% in September-a 26-year high. We think unemployment will climb further- to 10%, or more by early 2010-before starting a slow decline over the next several years. One of the reasons we expect the housing recovery to be so understated is the poor employment outlook over the next few quarters.

Meanwhile, the earnings picture is brightening. Companies across America are doing better, especially when compared with the awful results recorded late last year and early in 2009. To date, much of the recovery has come from cost cutting, however. Going forward, we will need to see stronger revenue growth to justify the higher equity prices now in place.

Investors are smiling again, after dramatic stock market gains this year. Now, the challenge will be to extend that positive momentum. This will not be an easy task given the ever-richer P/E ratios, which are now present, following the market's steep rise.

Conclusion: We think stocks can rise further. However, we caution that the market is now generously valued. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model's current reading.