The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

The third quarter was a dazzler, as we transitioned from recession to recovery in a big way. Specifically, the gross domestic product-which had contracted for four consecutive quarters-came roaring back in the recently ended period, rising 3.5%. That performance was underpinned by the now-ended cash-for-clunkers program and by uneven recoveries on the consumer and industrial side. The move into positive territory by the nation's economy concludes one of the longest and most painful business reversals in the past half century.

The recovery remains selective, with irregular performances on the retail, housing, and industrial fronts typically being the rule. What's more, it's worth noting that even where the headlines have been uplifting (such as the steady increases in industrial production in the past three months, the further strength at some discount chains, and September's jump in sales of existing homes), the recoveries have mostly come off of multiyear lows.

Meanwhile, there are some areas of concern. For example, auto sales have fallen following the conclusion of the celebrated cash-for-clunkers program, while housing starts, which rebounded some 20% during the first half of this year, have flattened out since June. Moreover, new home sales faltered in September as did consumer confidence. We are also cautious in our outlook for the holiday season. Finally, the shortfall in the availability of credit- a big factor in the severity of the recession-is still a roadblock to a full housing recovery.

We think growth will slow in the current quarter. Indeed, the uneven trends detailed above suggest growth may lessen to about 2% this quarter. We think this subdued pace will be in place to start the new year as well.

Nevertheless, the stock market's recovery has been nothing short of dramatic, with most equity averages-even after some recent backtracking-up more than 50% since the winter. With most investors longing for any good news in 2008 and early 2009, even the rather spotty economic revival cited above was enough to whet the appetite for stocks. Throw in better earnings news in the third quarter and the rally picked up for a while in October, when the Dow surged back above 10,000.

Conclusion: Now, with stocks higher and P/E ratios inflated, the bulls may need to produce additional good news to sustain the rally. Some caution is warranted, as a result. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model's current reading.