The stock market made nice progress in August and September, traditionally weak months, before retrenching a bit the last week of October as investors take a pause to digest the improving economic data. The Dow finished the quarter at 9712 after starting the quarter at 9171, a 5.9% increase, although it was up as much as 10% just 10 days ago. The event that grabbed attention in October was the Dow spending a couple of weeks above 10,000 – a mark it first hit back in early 1999 over ten years ago. The rise in the markets from the dark days of spring are mainly fueled by the continuing proof that the economy is rapidly recovering from the recession, almost completely due to intensive government intervention.

The good news is that GDP has gone from a minus 6.4% in the 1st quarter of 2009 to a minus 1% in the second quarter, to a recession-ending 3.5% positive growth in the recently ended third quarter. The U.S. manufacturing sector grew in October for the third consecutive month and at a faster rate than expected, and at the best rate since April 2006. The housing market has been rebounding from the worst downturn in decades, aided by aggressive federal intervention to lower mortgage rates and bring more buyers into the market. Completed home sales rose in September to the highest level in more than two years as buyers scrambled to complete their purchases before the tax credit of up to $8,000 for first-time owners expires on Nov. 30. The Fed`s efforts have helped lower mortgage rates - rates on 30-year loans averaged 5.03%, down from 6.46% a year earlier. “Cash for Clunkers” programs and massive government funding for education and infrastructure improvements are targeted efforts to spread around taxpayer money to promote economic growth, and in fact have had the desired, if temporary, effect. While the Fed has decided to end some temporary programs recently, such as the treasury buy-back, they are keeping for now various mortgage security buy-back programs into 2010 to continue to prop up the fragile housing market. The Fed`s benchmark interest rate is essentially zero, with speculation that it will be another six months to a year until they contemplate raising rates. In summary, the economic backdrop has vastly improved in the last six months and it appears that the U.S. is leading the world out of the crisis.

At the corporate level, there is also plenty of good news, of 358 companies in the S&P 500 that have reported quarterly earnings since Oct. 7th, 84% exceeded estimates. Earnings are in a “V” shaped recovery, and while most of that comes from drastic cost cutting, many corporate forecasts now include increases in revenue as deferred spending and investment, availability of credit, and government spending all work together to grease the engine of commerce. Things are not nearly as rosy at the consumer level. National unemployment creeps ever closer to 10%, foreclosure rates are at record highs as homeowners absorb a 25% drop in their home values, consumer spending is anemic, and consumer confidence is still very fragile after the turmoil of the last two years.

The system no longer seems to be in any danger of breaking, but there is a lot of mess to clean up and some things to watch out for on the horizon. There are a minority of analysts that believe that the next crisis lies in commercial real estate, which is probably the most depressed asset available right now. The issue is that most commercial real estate is financed by heavy leverage, most of which is collaterized on real estate values assessed during 2004-07, but with 2009 values probably 40% under the 2007 peak. Most of this debt will need to be refinanced this year, 2010 and 2011, before the \\\"bad debt\\\" based on peak prices works its way through the system. The public REITs have been able to retire this bad debt through additional stock offerings, common and preferred, but most private REITs have not been able to raise capital as the typical sources of lending, small banks, venture capital firms, etc have hamstrung these private REITs ability to raise either debt or equity capital. It is expected that the private REIT market will be selling real estate to pay off the revolving debt, and the winners are expected to be public REITs that don`t have a lot of revolving debt themselves to deal with and have cash from capital equity offerings to buy cheap real estate. The reason that a potential crisis is a minority view is that most of the commercial real estate debt is owned by private investors (rather than securitized and leveraged throughout the world like residential mortgages). So most believe that the financial system doesn`t have the kind of leveraged exposure to commercial real estate as it did to residential and, that while a problem, it is well known and shouldn`t come anywhere near to creating the kind of once-in-a- lifetime crisis as we`ve just survived.

Government spending has bought temporary economic stability and the start of some growth, but private business needs to join the party, spend, invest and hire, in order to achieve healthy long-term GDP rates above 3%. Our current reading of 3.5% GDP is artificially stimulated by government spending, programs, policies and a very accommodative monetary policy. It won`t last without private business and consumer participation. The government has put all the kindling on the fire, but it is corporate and consumer America that needs to take over and add long-term fuel. I believe it will happen, it always has in the past, but government policy will determine how quickly companies and consumers join the party.

The most critical aspect for long-term economic growth, and getting the stock market and real estate market back to breaking new ground, has to do with the coming timing of government monetary policies. Right now we have very low inflation and growth is the top priority, but keeping the pro-growth policies in place too long brings the threat of inflation, adds to national debt, and creates the potential for a loss of economic standing to the world`s investors. Conversely, removing the pro-growth programs too soon could stall the recovery, keep unemployment high and extend the “jobless recovery”, and severely limit the participation in economic recovery from corporate and consumer America. It is a fine-line balancing act, and we won`t know whether Ben Bernanke and company have it right for another year or two. But I believe it is a good bet that the Fed will get it right – we managed to survive the other giant recessions of history when far less fine-tuning was available. While not a slam dunk, I think there is a very good chance that – between the cleansing of the system, reduction in asset prices, and cyclical nature of the economy – we are lining up for another long economic expansion, which has been typical 80% of the time since World War II.