Despite the downward revision to GDP, a “v-shaped” recovery in corporate profits continues. Adjusted after-tax profits grew by 12.1% annualized, and at $1,197 billion annualized, they currently stand at their highest level ever. In addition, with 99% of companies in the S&P 500 having reported earnings, Standard & Poor’s currently estimates 2Q 2010 EPS for the index will be $20.99, an 8.3% increase from the first quarter.

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GDP for 2Q 2010 has been revised down to an annual rate of 1.6% due to higher-than-first-estimated imports and lower-than-first-estimated inventory accumulation. However, gains in personal income, pending home sales, and the ISM Manufacturing Index, combined with flat vehicle sales, suggest that moderate growth is continuing. While we think it is probable we will avoid a double-dip, we also recognize the current soft patch in economic data, and therefore expect GDP growth to be weak, but positive.

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The unemployment rate ticked up to 9.6% in the month of August, and although 54,000 jobs were lost overall, 67,000 jobs were added in the private sector. Last week’s jobless claims fell to 472,000, and the 4-week average fell to 485,500. A bright spot continues to be continuing claims, which fell 23,000, however, it is important to keep in mind that this reflects both hiring and the expiration of benefits.

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Consumer prices increased 0.3% in the month of July, led by an increase in energy costs, and producer prices increased 0.2%, led by an increase in food costs. Additionally, although the PCE price index showed a modest increase in July and average hourly earnings increased in August, the risk of inflation continues to remain low.

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The FOMC has stated that they will begin reinvesting the proceeds from maturing agency and mortgage backed securities into Treasuries as part of an effort to support a weaker than expected economic recovery. This will likely put additional downward pressure on interest rates, and along with the current weak patch in economic data, it seems probable that the Fed will keep rates low for an “extended period.”

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• Danger that political stalemate results in the expiration of all the Bush tax cuts.
• Credit conditions for individuals and small businesses remain challenging.
• Rising interest rates over the longer-term pose a threat to bond investors.
• Higher oil prices due to potential supply disruptions or geopolitical shocks.
• Sovereign debt woes and the potential for credit market stress.

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• Despite an impressive run-up, stocks still look cheap by conventional valuation measures.
• Large-cap and growth stocks look cheapest.
• High-yield and municipal bonds look cheaper than Treasuries, but a diversified approach to fixed income investing seems appropriate given economic uncertainty.
• Residential real estate continues to look attractive as a long-term investment.

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