Economic Outlook

Economy Gradually Showing Signs Of Stabilizing

Recent economic news paints a picture of gradual emerging stability in the U.S. economy. However, structural stresses — like a depressed housing market and lingering toxic assets at banks — remain, so we do not appear to be out of the woods yet. The fundamental forces driving improvement are low interest rates and government stimulus, the lagged effects of lower energy prices from this time last year, and growing pent-up demand. Recovery in the rest of the world will likely lag the U.S., with a few possible exceptions (e.g., China). Core inflation is moderate and stable for now, and its future direction likely will hinge on how well the Federal Reserve (the Fed) manages the large stimulus the government injected into the economy. In the near term, excess capacity and moderate wages suggest there are few inflationary pressures.

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Equity Portfolios

Earnings Improvements Could Boost Equity Price

The market prices of U.S. stocks as measured by the S&P 500 appear to be trading at levels that are about 20% below their fair value based on the broadest – and most balanced – measure of profitability. In the current environment of lingering uncertainty, this gap may not close until there is more evidence of economic stability. In fact, prices could first decline if there is evidence suggesting economic recovery will be delayed. However, we feel that any near-term price weakness should be temporary, and prices should move higher from current levels as signs of economic stability mount

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Fixed Income Portfolios

Medium-Term Bonds Capturing Yields, Limiting Risk

In the second quarter, treasury yields continued the upward trend started at the turn of the year. Both short- and long-maturity bonds showed this pattern, although longer maturities saw a sharper rise in yields. As a result, the shape of the yield curve became steeper. This is often consistent with a market assessment that growth will accelerate and, potentially, so will inflation. Corporate bond yields behaved differently. After rising sharply throughout most of 2008 and vacillating wildly in the first quarter, corporate bond yields declined and their market prices increased in the second quarter of 2009, making corporate bonds among the best-performing asset classes

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