Recession talk can be a self-fulfilling prophecy. However, strong productivity and corporate balance sheets have enabled the economy to remain quite solid. Consumer confidence is starting to rebound. The IBD/TIPP gauge of Economic Optimism shot up over 24% in November. Falling gas prices, economic rescue plans and the presidential election have lifted confidence. Unfortunately, no one has told the media and politicians.

The Federal Reserve has created a dramatic increase in the monetary base. Unprecedented! It will take time, but it's setting the stage for the next expansion. Big implosions often lead to big expansions.

In our opinion, the Federal Reserve has acted wisely. We are lucky to have Ben Bernanke. In addition to an Ivory League education, he has written three textbooks on macroeconomics and one on microeconomics. Oddly enough, Bernanke's hobby is studying the economic and political causes of the Great Depression. He has written extensively on this subject. We are in good hands.

The Fed's first move was to apply triage to the banking crisis. In a short period of time, the government has taken over Fannie Mae, Freddie Mac and AIG. They orchestrated accelerated mergers of Merrill Lynch, Bear Stearns, Washington Mutual and Country Wide. Their final dose of "antibiotics" (the bailout) are just starting to take affect.

How bad is the banking system? The FDIC reports only 13 bank failures from January 2007 through mid September 2008. By comparison, there were 15 in 1999 and another 15 in 2000. The Savings & Loan crisis produced failures in the thousands. Since the Great Depression, the average annual number of bank failures has been 94. Stats can be misleading, but we are way below that level.

How bad is this mortgage meltdown? Mortgage Bankers Association reports that 6.4% of mortgages are delinquent, that's delinquent, not in foreclosure. Only 2.75% of all mortgages are in foreclosure. During the Great Depression the foreclosure rate was around 50%. Today, the majority of foreclosures are concentrated to the sub-prime market. Sub-prime mortgages account for 12% of all mortgages, but make up 52% of all foreclosures.

Across the board, home values are starting to stabilize. The National Association of Realtors reports median price of an existing homes are starting to increase. They report median prices are actually up 8.5% from the low of February 2008. Supplementary data supplied by the U.S. Census Bureau reports a 1.3 increase since December 2007. While some geographic pockets may be experiencing declines, aggregately, declines in U.S. housing prices have slowed.

How's the overall economy? The US economy grew at a rate of 3.35 in second quarter. The average growth rate since the Great Depression has been 3.4%. We have had 11 recessions since the Great Depression; right now we are nowhere near the 12th. In fact, export growth and non-defense capital goods orders are running at levels that indicate expansion. The Institute for Supply Management Manufacturing Index (Manufacturing ISM) is running at tolerable levels. Other than employment (which is a lagging indicator), it is difficult to find indicators running at recessionary levels.

We have never seen a surge in the monetary base like we are witnessing today. On October 29, the Federal Open Market Committee lowered the Fed Funds Rate to 1%. This process created a title wave of liquidity. It's the equivalent of a rich relative dumping buckets of money at your doorstep, with a sign attached that says "Help Yourself". Year over year, the monetary supply is up by 48%. Unprecedented.

Money is used in most economic transactions. Increased money supply works by lowering interest rates, and putting more money in the hands of consumers. It creates investment. It makes consumers feel wealthier, which increases spending. It doesn't happen overnight. But as it unfolds businesses will respond to their increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. Stock market prices will eventually begin to rise.

Over the last 82 years, the market has had positive returns 72% of the time. It has been down greater than 20% only 5 times. Markets typically post a 25% return in the 12 months following a correction.

From December 31, 1997 until December 31, 2007 the S&P 500 realized a cumulative return of 77.56%. But, if you were out of the market the results would be different.

• If you missed the 10 best days of the market your annualized returned would have been: 1.12%
• If you missed the 20 best days of the market your annualized returned would have been: (2.55%)
• If you missed the 30 best days of the market your annualized returned would have been: (5.72%)

Please advise us promptly if there are ever any changes in your financial situation or investment objectives. Feel free to give us a call if you want to discuss anything further.