The Value Line Investment Survey

ECONOMIC AND STOCK MARKET COMMENTARY

U.S. retailers ended the recently concluded quarter with a whimper, posting a modest 0.3% drop in sales in December on reduced activity at such diverse merchants as specialty retail chains, general merchandise outlets, electronics and appliance stores, and auto dealers. This modest final-month reversal, following solid gains in October and November, put the finishing touches on a grim year at the retail counter. The lackluster December sales results underscore the hurdles still facing the economy as it strives to recover from the most severe recession in decades.

The industrial sector did better, as the nation's output rose 0.6% last month, equaling the November gain, while U.S. factories again raised their activity levels, producing at 72.0% of capacity. Although both categories remain below the strong 2004-2008 levels, they are up nicely from the mid-2009 trough.

Housing continues to be a drag. Here, as well, we are up from the 2009 recession lows. However, the setback in housing was exceptionally severe, and the staggering level of foreclosures-2.8 million properties were threatened with such action in 2009, while foreclosures and bank repossessions could rise again in 2010- does not augur well for a broad recovery in this sector in the year ahead.

All of this suggests that the economy will recover in fits and starts in 2010. Our sense is that the nation's gross domestic product will grow at 2.5%-3.0%, on average, in the coming four quarters, after a likely snappier close in 2009.

The earnings picture is brighter. Most companies reporting in recent weeks have either met or exceeded expectations, with much of the pickup having reflected greater productivity. The challenge going forward will be to generate the revenue growth that has been largely absent in the formative stages of the business up cycle. The recent lackluster revenue gain at IBM, which helped to spark a selloff in that blue chip and the market, in general, is a sign, along with uneasiness about the President's call for tougher bank rules, that equity investors may not continue to be universally forgiving.

The bulls have had a good run, as they have watched their portfolios recover strongly over the past year. Much of this optimism has been likely fueled by expectations that Corporate America will deliver strong revenue and profit numbers in the months to come. Our sense, judging by the cool reception given the IBM report, is that such a delivery will be needed if the equity market is to make additional, meaningful progress this year.

Conclusion: The market may have further to go on the upside, although we sense that such future gains will be harder to come by. Please refer to the inside back cover of Selection & Opinion for our Asset Allocation Model's current reading.