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Dissonance

This year, which began with such great promise, is a disappointing one so far for the equity markets. In addition to fears of global terrorism and the polarizing tendencies of election year politics, new concerns about the economy have emerged, brought about by a softening of some important indicators in recent months. In particular, new jobs were up less than expected in June and both housing starts and industrial production showed a decline. These declines have cast doubt on the sustainability of the recovery. As a result, the stock market has given back the modest improvement of the second quarter and is essentially flat for the year.

Entering 2004, the missing links in the otherwise positive direction of the United States economy were job growth and a broad advance of foreign industrial economies. Since then, both have experienced a sharp turnabout that we believe is likely to lead to a renewed period of sustained economic growth. New jobs creation has been positive every month since last summer, with a near record 139 million Americans holding jobs at the end of June. With new jobs expanding at a satisfactory pace, personal incomes are also being maintained. Real wages, i.e. wages deflated by increases in inflation, are approaching the record levels of several years ago and disposable personal income continues to grow. If energy prices decline in the coming period, as we believe they will, real wages will receive an additional boost. With these attractive qualities as background and continued remarkable strength in the housing market, consumer confidence has remained very positive, suggesting that the recovery is being increasingly felt at the grass roots level. Absent some shock to our financial system this is not a set of circumstances that is subject to rapid change or deterioration.

On the international side there has been clear improvement since the turn of the year. In Japan, the world’s second largest economy, economic indications continue to exceed expectations. Japan’s first quarter GDP was much stronger than expected. Similar to the situation in the United States, employment growth in Japan has been strong and the unemployment rate has fallen. Profit growth is accelerating and continues to finance a sharp pickup in business investment spending. There are also modest signs of improvement in the two largest economies among the 12 nations using the euro. The French economy is predicted to grow faster this year than expected earlier after indications of stronger consumer spending in the past few months. Thanks to robust exports to the United States and Asia, German central bank officials are predicting a slightly stronger economy ahead for that country.

The economic picture is healthier today then it was even six months ago. The economic expansion has broadened considerably in the United States and now includes manufacturing and exports. The reduction in the rate of growth of consumer spending has been less then anticipated, although as time goes on consumer spending may recede somewhat further. The positive trends of many economies throughout the industrialized and developing world is a welcome and timely development which adds balance and depth to the expansion. We believe that the apparent slackening of growth recently is not an early warning sign but a "shifting of gears" within our economic engine. The outlook for the economy continues to support a positive view toward the equity markets.



Investment Policy Committee
Alfred A. Lagan, CFA, Chairman
July 30, 2004


The opinions expressed herein are those of Congress Asset Management and are subject to change without notice.


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