2003 was a banner year for the U.S. stock market as investors were nicely rewarded across the board. The Dow Jones industrial average was up 2,112 points for the year and closed on December 31, 2003 at 10,737. Although the January 14, 2000 high of 11,722 was not remotely challenged, the mood of stock investors at the beginning of this year sent positive indications that brighter times were just around the corner. Most forecasters were betting that a better economy, good earnings, and low interest rates would set the stage for a robust stock market in 2004 but an unexpected bear jumped into the fight. And today, the question is WHY? With the Dow down at the 10,000 level and the P/E multiple for the S&P 500 at 15 times the projected 2005 earnings, one would assume that stocks are cheap. But, with uncertainties in regard to oil prices, terrorist pressures world wide, a rising interest rate environment, and political bashing, it is not easy to jump in with both feet.

Conversation about the stock market is important today because stock investors historically look out 12 to 18 months in an effort to determine economic growth as it relates to corporate activity and earnings. If the stock markets were testing new highs on a regular basis rather than new lows, it would clearly signal that forward GDP growth was sustainable at a 4%-5% rate. However, stock investors seem a little pessimistic at the moment and are suggesting that something less than 4% is not impossible. So, the next important question to ponder is: are we slowing down or not?

Our opinion is one of optimism. Think about the transportation index which is setting new highs while the Dow is off 700 points from its recent high, and it is easier to see that something good is brewing. If the railroad and trucking industries are doing great, then the industrial side of the economy must certainly be in very good shape. So, a soft patch perhaps, but not a retreat to slower growth and reduced confidence.

Now it's back to interest rates, the Fed, and politics. With few exceptions, the financial markets are focused on the Fed's August 10 FOMC meeting and their views on inflation. Mr. Greenspan conveyed an upbeat outlook for the economy in his semiannual testimony before Congress and suggested that another rate hike in August is in the cards. The bond market is poised for a 25 basis point move as the 90 day bill rate is approaching 1.50%, which is always an indicator of interest rate posture. We believe that the Fed will raise rates in August and again later in the year. Both rate hikes will be important signals by the Fed that inflation will be managed on an ongoing basis but not at the expense of non- inflationary growth. One point to remember is that the crowding out effect is not in play this time around and will keep rates from rising too fast and too much. The old logic as the economy starts to do better is many companies borrow more money and force rates higher. However, corporations are sitting on more cash since such records have been kept and their operating margins are off the charts as they have been cutting costs for 4 years. It is likely that margins will come down some as they start to beef up staff but growth can be generated from cash on hand and cash flow.

The presidential election has swung into full force with the country divided almost in half. Uncertainties in regard to the outcome have put many investors clearly on the sideline. While we believe that both stocks and bonds present good investment opportunities, we appreciate the caution displayed in both markets. Stocks in particular are poised to rally from current levels. There are record shorts in the market, large mutual funds are sitting on record amounts of cash and are underinvested, money market funds are in the 4-5 trillion dollar range, the S&P is 20%- 30% undervalued, and everyone is certain that bond yields are going a lot higher. With all said, we don't know what gets the bulls going but all the bearish pressure will certainly dissipate when no one is looking.