The period since March has witnessed the most painful stock market since the third quarter of last year, a true echo of the aftermath of September 11. This time, however, the wounds are partially self-inflicted. The bankruptcies of Enron and Global Crossing and the complicity of accounting firms, lawyers and others, unleashed an intensive scrutiny of the actions of financial institutions. Some prominent companies have fallen as a result of the findings, and others are seriously impaired. Self-absorption, loose accounting, deceptive practices, and enormous greed have caused a serious loss of confidence in the integrity of the financial markets. As if these revelations are not enough to fray people’s nerves, daily reminders of the war against terrorism and the fragile world political situation are weighing heavily on investor confidence.

The sour mood of the stock market belies the steady improvement in the economy. Moreover, early indications point to a healthy broadening of the recovery. The weakest area of the economy in the last recession, manufacturing, is firmly on the mend and gaining strength. According to the authoritative Institute for Supply Management, manufacturing activity in May posted the strongest gain in over a year, with new orders advancing for the last four months. The increase in orders was confirmed by the latest report on factory orders from the Commerce Department, which tallies five consecutive months of improving orders. The conditions for a continuation of these trends are propitious. New orders have outpaced production across a broad array of manufacturing activity, including business investment. Many observers believe a rise in business investment is crucial to a sustained recovery. Also arguing for further gains in manufacturing is the lean state of inventories, which are light by historical standards. The rising pace of sales relative to production has kept inventory levels low, and indicates a further rise in industrial production in the months ahead.

There are other stirrings of a healthy economy, which are being overlooked in this discouraging period. The government has reported that productivity advanced 8.4% in the first quarter, after an increase of over 5% in the fourth quarter. These are exceptional increases. While they cannot be sustained at these levels, they suggest that the productivity improvement experienced during the 1990’s is alive and well. Furthermore, there appears to be a structural shift upward over the productivity gains of earlier periods. During the 1990’s productivity advanced at a pace of around 2% per year, and for the twenty years before that it grew at 1.4% per year. Increasing productivity is a necessary ingredient for an improvement in employment and corporate profits in the near term, and continuation of America’s economic hegemony over the long term.

The acceleration of productivity growth, which is widespread throughout the economy, has positive implications for inflation and for a recovery in corporate profits. Broad measures of inflation are essentially flat this year. Unit labor costs pose no threat to this benign outlook, nor do energy costs, which appear to be declining. Intense competitive pressures are keeping a lid on price increases elsewhere. Under current conditions rising sales trends will flow directly to the bottom line. The surprise of the second half of this year will be the powerful resurgence of profitability of corporate America.

Consumer spending, which fueled the strong economic advance in the first quarter has slowed, but remains basically healthy. Housing in particular has confounded those observers who have been expecting a severe decline. The remarkable staying power of the housing market is a function of low mortgage rates and ready availability of money. Both indicators remain supportive, and demographic factors are also positive. Home ownership is one of the most basic goals of every working family, and its availability is one of the unique attributes of our capitalist society. Immigrants especially have a strong yearning for a home of their own to raise their families. We believe the housing market will remain one of the positive factors in our U.S. economic recovery going forward.