Economic and Investment Forecast
June, 2008

The U.S. economy continued to be resilient, growing slowly through the first few months of the year despite the housing/sub-prime mortgage and credit crises, rapidly rising energy and food prices, and low consumer confidence.  The weak dollar, which makes our exports attractively priced overseas, and government spending for the wars in Iraq and Afghanistan, enabled the gross domestic product (GDP) to increase by 0.9% in the 1st quarter.  The GDP may have turned negative in April as oil prices have skyrocketed (+41% from 1/1/08 – 6/9/08), placing a severe economic strain on consumers and businesses and making a recession (2 negative quarters of GDP) more likely.  Higher energy costs also contribute to inflation, which can spill over into other areas of the economy, leading to an upward wage price spiral.   However, most energy analysts believe that a significant portion of the oil price increase is speculative, and expect that the price will decrease in the next few months, reducing inflationary pressure on the world’s economies.  There are considerable differences in analysts’ forecasts as to when and how much the price of oil will decline.  Whether or not oil prices fall in the short term, stronger economic growth, an expanding world population and a rising middle class in developing countries will most likely drive energy costs higher again over the next few years. 

The Federal Reserve lowered interest rates, despite signs of increasing inflation, in order to address the sub-prime mortgage/housing and resulting credit crises.  Although the losses from the sub-prime mortgages have been mostly written off by the financial institutions, credit card and other debt are problematic.  The housing crisis tends to be a local issue where some areas have seen dramatically reduced values, while others have experienced very little decline.  Nationally, there is currently about an 11 month inventory of unsold homes and the average price has declined by 16.6% from the high in August 2006.  The credit crisis remains a barrier to expanded economic growth, but should gradually diminish as the Federal Reserve is providing significant liquidity to financial institutions.  Federal Reserve Chairman Bernanke recently expressed concern about the weak dollar and its effect of raising inflation (3.5% for the past 4 quarters), but there appears to be enough slack in the U.S. economy at this time to preclude a significant rise in core inflation (a measure of inflation that excludes volatile items, such as food and energy).  The Fed, as well as the U.K. and EU Central Banks, will probably leave interest rates unchanged for now, until they decide which to address - the weakening economy or inflation.  The bias seems to be toward controlling inflation.  Also, the Fed is reticent to make any changes before the presidential election.  The U.S. economy may have a quarter or two of weak or even negative growth before gradually recovering.  Economists expect the GDP to average only about a 1% increase during 2008.  Although most major foreign economies have weakened from high oil and food prices and slower export sales to the U.S., a worldwide recession is not expected.

The S&P 500 Index achieved its highest level on Oct. 9, 2007 before falling approximately 18.7% by March 10, 2008.  Through June 9th the S&P 500 Index is 13.0% below its record high (-7.3% 2008 year to date).  However, not all stocks followed the trend as numerous multi-national corporations, especially technology, posted strong earnings primarily from foreign operations.  The stock market will likely continue to be volatile due to the uncertainty over the price of oil and food, the direction of the economy, inflation, interest rates, and the presidential election.

Diversified Financial Management, Inc.
A Registered Investment Advisor with the Securities and Exchange Commission.