Financial forecast.

• Author: Boquist, John

The Dow Jones Industrial Index hit a record high in October by crossing over the 12,000 threshold, yet investors are not wildly celebrating. Part of the reason is that the Dow does not denote the "stock market," since the thirty stocks comprising the index are not fully representative of the entire market. For example, the broader S&P 500 Index reached a high of over 1,527 in March 2000 and currently stands at only 1,377. More discouraging, the current NASDAQ Index for smaller, over-the-counter stocks is at 2,350, less than one half of its record of 5,048 also set in March 2000. These broader indexes clearly suggest that many investors retain bitter memories of the bursting stock market bubble and indicate that the markets have a long way to go before recouping their realized losses.

After the stock market collapse, many investors shifted to real estate speculation fueled by low interest rates, double-digit price increases, and intense baby boomer participation. Unfortunately, the real estate market has recently cooled, with the August median sales price for an existing home down 1.7 percent from a year earlier, the first yearly drop in over a decade. As investors search for the next hot investment, they never seem to heed Kin Hubbard's advice, "The safest way to double your money is to fold it over once and put it in your pocket." Since consumer spending continues to grow, investors are not putting money in their pockets and they certainly are not saving it--the U.S. savings rate on a national income account basis is now -1.7 percent, down from 12 percent in the early 1980s!

Of course, there are some notable bright spots in the financial picture:

* Energy and commodity prices are now dropping, providing welcome material and psychological relief to consumers and businesses.

* The Fed appears to be finished with interest rate increases.

* Corporate income and balance sheets remain strong.

With this as a backdrop, the question on everyone's mind is, "What does the future hold?"

Interest Rates

The new Federal Reserve Chairman, Ben Bernanke, continued the Greenspan initiative of increasing the short-term federal funds rate until August 2006, ending with 17 consecutive 25 basis point increases to a level of 5.25 percent. Such increases are likely to be finished if the economy's core inflation rate has moderated and the Fed no longer sees its main job as fighting inflationary pressure. We believe that job is completed and that the federal funds...