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Revisions, though dramatic at times, rarely get the same notoriety as the original pronouncement. Often, however, they alter the entire picture, as in the present case. The strength in personal consumption throughout the recent slowdown, in spite of the decline in housing and mortgage refinancing, is clarified by the surge in employment. Combined with rising personal incomes and solid confidence, consumer spending is quite likely to remain strong through the remainder of 2006 and into the New Year. The resilience of the consumer has confounded those observers who have expected a consumer led decline leading to a recession next year. Nevertheless, there are pockets of weakness in the domestic economic picture which will pull down aggregate economic yardsticks for a while. Housing, in particular, is on a slide after years of out-performance. The weakness in housing is most evident in new home sales, which have declined approximately 20% from the peak. Building permits have also declined indicating lower residential construction in coming months. National homebuilders ignored signs of overbuilding which began to appear a year ago, and now have large inventories of unsold houses. It will take time for this imbalance to be worked through. The housing imbalance, however, is a cyclical problem, not a long-term weakness. The passage of time will allow excess inventory to be absorbed. The corrective process may already be underway. Affordability is improving as house prices decline and personal incomes rise. Mortgage money remains plentiful and inexpensive. Favorable demographics in the home buying years support an optimistic longer-term outlook for the housing sector. Increased immigration and formation of households by the children of baby boomers provide a firm foundation for increased housing once current cyclical problems are behind. The automobile sector is another area of concentrated weakness. There is no pent up demand for new cars in the United States, as there is in emerging markets, where foreign competitors often have an edge up. Domestic auto manufacturers have lost their leadership roles to foreign competitors. There are many reasons why legacy manufacturers such as the domestic automobile companies are in a long-term state of decline. In our view weakness in this sector is chronic, and will continue to have a depressing effect on our economic growth. Generally, other sectors of the economy are doing well. Retail sales are robust, and construction outside of residential housing is holding up well. Exports are rising, validating the more rapid expansion overseas. Capital spending trends remain positive, although slowing somewhat. Agriculture is very strong. Strength in these sectors is sufficient by themselves to maintain the current expansion, although at a more subdued level then earlier in the year. Consumer spending seems poised to accelerate, materially reducing any downside risk. Rising employment and incomes, and falling gasoline and natural gas prices, are removing the specter of a collapse of consumer spending. On top of solid performance elsewhere, we believe a resurgent consumer will propel the U.S. economy to enter 2007 with rising economic momentum. Inflation is the biggest threat to continuation of a stable and prosperous expansion, in our opinion. While headline inflation has declined, due to the drop in gasoline prices, inflation at the core level, i.e., stripping out gasoline and food prices, has remained stubbornly high. The revisions in the job surveys raising the number of new jobs created in the past year and a half points to a vibrant labor market. Rising wages and the large increase in withholding taxes paid, further attest to the strength of the labor market. If the economy accelerates as we believe, inflation pressures are likely to persist above the Fed’s comfort zone. For this reason we maintain our belief that there is a 50/50 chance that the next change in interest rate policy by the Fed will be up. In our judgment, the sturdiness and flexibility of the United States economy is brought into clear focus during this period of apparent slowdown. The weakness in housing has not translated into a decline in consumption. Other growth drivers have kept the economy on a positive track. Worldwide growth has caught up to and surpassed the United States growth, opening new outlets for American products and services. This spreading out of the fruits of economic development to other areas of the world is not only healthy for all, but vital for a peaceful future. Clearly we do not share the current concern for a lurking recession. We believe we are in a long duration, worldwide expansion. Investment Policy Committee Alfred A. Lagan, CFA, Chairman Daniel A. Lagan, CFA, President November 11, 2006 This information is intended solely to report on investment strategies and opportunities identified by Congress Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell of any financial instrument. 2 Seaport Lane Boston, MA 02210 www.congressasset.com
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