June 18, 2002

The futures markets expectations look for the short-end of the yield curve to rise approximately 20 basis points between now and the end of the third quarter. From that point on, we expect a steady rise in yields at the short-end of the curve. Our outlook is for a flattening of the slope of the yield curve. Given the markets expectations and the historical variability of the yields, we estimate the likelihood of the long-end outperforming the short-end of the yield curve to be 1 in 2 during the third quarter. We believe that inflation is under control and that the Feds actions are loosely guided by the price rule. Hence, we take the position that the futures market is signaling a rise in the real rate. In short, it is our belief that the recovery will continue. In our opinion the disconnect between the market and the economy should come to an end soon and at that time the markets will catch up to the recovery. Based on our forecasts, the probability of equity outperforming the fixed income market is estimated to be 70.4% during the third quarter. We always ask ourselves what could go wrong with our forecast. One issue that immediately comes to mind is the Enronitis. If the corporate governance issues do not improve, the market woes could continue. Another issue that we have not factored in is Iraq. Are we going to do anything about the axis of evil? (full article attached)

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