What's Next? The employment picture looks bright, prospects for economic growth and profits remain positive, escalating energy prices have peaked, stock market sentiment is robust, and bond yields are creeping higher. Investors are feeling good about the brighter view, and while many still argue that tough times will persist, we believe that this is only the beginning. We think that the market is very comfortable with the jobs picture and the state of the economy, and has already discounted a June rate increase by the Fed.

While uncertainties persist in regard to Iraq and the 2004 national elections, the over-all market mood is quite good. U.S. employers added 248,000 workers to payrolls in May, fueled by the biggest gain in manufacturing in almost six years. Payroll employment has increased by 1.2 million so far this year which has us on track for an attainable 3 million new jobs for 2004. Over the last 3 months we have averaged better than 300,000, which is reason to suspect a modest rate increase by the Fed at it's June 30 FOMC meeting. Energy prices are playing a significant role in the Fed's review of the economy, and with oil above $40 a barrel, we are plagued with higher gas prices at the pump. Gas at $2.00 plus per gallon, coupled with robust employment gains, sends an inflation message to the boys at the Fed. However, we believe that oil topped at $42 per barrel and is now working its way back below $38.50 and possibly down to $33 by this winter. So, in our opinion, a 25 basis point hike in the funds rate is almost a certainty and another 25 basis points after the election.

Looking at today's yield curve, which is the steepest on record, it is saying that the economy has a huge platform from which to do better. Real GDP expanded at an adjusted 4.4% rate in the first quarter, with a much faster than anticipated building of inventory. We think the next 3 quarters will improve over the first quarter and could perhaps excite the more optimistic forecasters. Many of out larger companies are more efficient, richer, and profitable than they were 6 years ago. Also, less competition, with significantly larger markets, is beneficial to our exporting businesses. All-in-all, the news is very good and the markets are starting to believe it.

Back to the yield curve for a moment. At this point, we think investors are beginning to realize that a normal spread from overnight funds (currently 1.00%) to the 10-year note (currently 4.80%) is 125 basis points, and the current spread of 380 basis points is either saying that funds are going to rise above 3.50% or bonds are attractively priced. If the Fed raises rates from 1.00% to an anticipated 1.25% on June 30th and another 25 basis points by year end, then the spread to the 10-year is 330 basis points. This would suggest that the bond market is looking for rate increases of 100-175 basis points by the end of 2005 or that bonds are attractive for purchase. We are of the opinion that purchases of bonds between 2 and 5 years make investment sense and will produce less risk than remaining in shorter term instruments. Keep in mind, the 90 day bill rate has edged upward to 1.20% and is the best indicator of a near term move by the Fed.

So, what's next? The economy is growing, inflation is low, yields are high, and sentiment is good. Plus, we will be winding down our presence in Iraq, which is healthy for both stocks and bonds. The national elections should not interfere with our outlook for interest rates or the economy. Expect exciting things from the financial markets over the next 18 months. Some bumps along the way but a positive trend.