There are solid and logical reasons why equity markets have been up substantially since the start of the third quarter. The U.S. economy remains in a fragile situation and the global financial system is far from healthy. Nonetheless, progress is being made and, barring any new crises or setbacks, the case for the market's recent rise can be justified. What's different this time is that two sectors that have traditionally led economic recoveries in the U.S. - consumer spending and real estate - will remain on the sidelines for the foreseeable future.

In a recent address at the home of Google executive Marissa Meyer, President Obama implied that there has been a lack of innovation in the American economy in recent years. As Bespoke illustrates in a chart provided, however, the number of U.S. patent applications granted has increased steadily each year since 2000, with the exception of 2005. In fact, many have argued that it has never been cheaper for someone with an idea to spread and develop it.

Taken together, initiatives enacted under the Troubled Asset Relief Program will provide up to $45.6 billion in home mortgage foreclosure relief. Proponents of these programs argue that if they finally stabilize the housing market and pricing, all homeowners will benefit. Opponents believe they create a huge problem of moral hazard in the residential housing market. They also point out that stabilizing home values above what may be a lower floor based on market supply may preclude other individuals from being able to enter the market and purchase a home they can afford.

Low yields, high corporate debt issuance, increased monetary stimulus and the rising dollar do not mean that growth will accelerate any time soon; the outlook of a slow and meandering recovery still holds. Corporations continue to rebuild balance sheets and margins at the expense of hiring and investment. While this bodes well for future debt repayment, the outlook is not rosy for job seekers. When the job outlook does change, however, and the economic pulse quickens, the era of low interest rates could end quickly.

Housing is still deflating, but commodities are mixed. The concern longer term is that the Fed is printing money in order to stimulate the economy. At some point, all this liquidity in the system could cause inflation to accelerate, perhaps to a level that the Fed cannot contain. We are not forecasting either serious deflation or serious inflation. On the other hand, we do not regard the probability of a negative outcome as trivial.

While much shorter and less severe than the Great Depression, the recession of 1937-1938 added approximately three years to the recovery period. It is extremely unlikely that we will see a repeat of this type of recession. However, depending on the outcome of elections in November, there could be substantial shift in the fiscal and taxation policies of the federal government away from Keynesianism and toward fiscal discipline and supply side economics.

The Intrade odds for the Republican Party to win the House of Representatives have been well above 50 percent for some time now (currently at 75 percent), but the Democratic Party has been favored to retain the Senate throughout the Intrade contract's entire history. Today, however, that contract fell below 50 percent for the first time, and the odds are currently at 47.5 percent for the Democratic Party to keep a Senate majority.

The Fed's prediction that it will keep its short-term interest rate target at 0-0.25 percent for 'an extended period' continues to affect the near-term game plan for risk-averse investors and savers. A period of potentially heightened uncertainty and low absolute returns means that maximizing risk-adjusted returns is crucial to investment success over time. An optimized mix of fixed income holdings with a variety of different risk levels can add value to investor portfolios in this low-yield and low interest rate environment.

A recent Wall Street Journal article highlights the macro-driven nature of today?s stock market. Long-time value investors lament the current environment where stocks appear to trade in unison based on unemployment data or European bank stress test results. If stocks are driven by macro factors instead of company fundamentals, stock pickers can?t get an edge. We think stock-picking is very much alive. Call us contrarian, but we couldn?t think of a better sign that fundamentally-driven, bottom-up stock-picking is likely to make a comeback sooner rather than later.

Although U.S. oil inventories declined by 475,000 barrels in the latest week, the decline was less than the forecasted decline of 700,000 barrels. As shown in charts provided, oil inventories in the U.S. are currently right near their highest levels of the year relative to the historical average. Since oil stockpiles peaked earlier in the year, inventories have declined by 2 percent. In an average year, however, oil stockpiles are down 6 percent from their seasonal high by this time.

Last Friday's Consumer Price Index report found that prices rose 1.1 percent on an annual unadjusted basis in August. Because the U.S. Federal Reserve Open Market Committee noted in last week's statement that inflation is currently at levels somewhat below what it judges to be consistent with long-run price stability, some have suggested that the central bank is still concerned about deflationary pressures in the economy. Whatever happens, one thing is clear: As long as the residential housing crisis drags on without resolution, the risk of deflation should remain a concern for investors.

Among the first items the U.S. Congress is likely to deal with after the midterm election are the federal budget deficit and taxes. The accepted wisdom is that markets prefer the more incremental change based on political compromise brought by divided governments. However, median returns data looking back 60 years do not provide any strong support for this. Indeed, if a divided government leads to intransigence and gridlock, then it will take another two years and the next general election before key issues can be addressed.

This week the Japanese government decided to intervene in the foreign exchange market, initiating a vigorous campaign to buy U.S. dollars, thereby stemming the rise of the yen and pulling up the greenback. The effects were immediate, with the yen falling an astonishing 3 percent on the day of the announcement. The media spin doctors cast the Japanese decision as an attempt by the island state to prop up its own fragile economy. The intervention was actually done to help American consumers buy more cars and electronics from Japan.

By preventing additional redistribution policies, the split government that will likely emerge from the November U.S. midterm elections will probably loosen some purse strings to invest, hire and grow. However, we probably will not see any policies that will meaningfully change the overall economic condition or the outlook for equities as an investment. The next two years will thus most likely bring a Woody Hayes economy - 'Three yards and cloud of dust'- meaning we will have some renewed economic activity, but not the sustained, robust growth to be expected coming out of such a long slump.

The Fed has kept interest rates near zero and has purchased more than $1.5 trillion in Treasury and agency bonds in order to inject cash into the banking system. Although there has been disagreement within the Fed, interest rates will remain low. Free enterprise has worked for us for several hundred years. There have been and always will be recessions and even financial panics, but markets have the propensity to straighten themselves out.

Despite considerable discussion in the financial media about the existence of a bond market bubble, the fixed-income team at American Century Investments finds little evidence to support this claim. Bond bubble proponents base their argument largely on record flows into fixed-income investments, bonds' extended outperformance over stocks, and record low interest rates. However, a confluence of economic headwinds argues for a prolonged period of low interest rates and inflation, while investor demographic and behavioral finance trends also appear to favor further bond inflows.

Most technical analysts believe that chart patterns tend to repeat themselves. Using quantitative analysis, Bespoke went back and compared the last six months in the S&P 500 to every other six month period since 1928. They found that the stretch that most closely resembles the last six months is the period from November 1959 through May 1960. While the majority of investors still believe we will avoid the double-dip recession this time around, the 1959 to 1960 example suggests that even if we do go back into a recession (as we did then), a new bear market is not necessarily a sure thing.

Labor disputes in China and other emerging market countries have been catching global media attention. As employees in the low-cost workshops of the world fight for higher wages and better working conditions, the longer-term outcome will be better standards of living and rising disposable incomes in emerging market countries. These changes hold positive implications for many global-based companies' present and future growth. A growing consumer class with 'buying power' will certainly be beneficial.

Merger and acquisition activity has jumped dramatically in the past few months. The good news for investors is that increased M&A activity can help sustain the market during a period of economic softness or a slowdown that we may face in the next several quarters. The risk for investors is whether the money spent on M&A activity will be done wisely and with a clear eye on creating shareholder value. If not, that money is probably better spent buying back shares or increasing dividend payouts.

As the developed world stumbles from crisis to crisis, many developing countries seem poised to continue taking a greater share of the world's wealth. This trend, however, is not an automatic signal to invest. China, India and Brazil, the most sought-after developing markets, now demand double-digit multiples, and have higher inflation and monetary growth than developed markets. These factors suggest that the margin of safety is significantly smaller in developing markets than in developed markets.

A growing number of investors are calling the bond market a bubble. Bespoke presents a chart showing the yield on 10-year Treasury bonds minus the year-over-year change in the CPI. Using this method, the adjusted 1.62 percent yield on the 10-year bond is still below its historical average of 2.66 percent, but nowhere near historical extremes. While one could make the argument that Treasury bonds are unattractive due to increased supply and their low yields relative to other periods in the past, it is hard to argue that their current valuation fits the criteria for a bubble.

While opening up its equity market to foreign retail investors will likely benefit India and increase capital inflows in that country, there is also more growth potential for investors who are prepared to accept the risks and invest for the long term. Over the next five years, India and emerging market economies will be driven not only by export demand from the rest of the world, but by growth in domestic consumption, including health care, technology, infrastructure, and finance. This will create huge opportunities for investors and companies doing business in these sectors.

There has been a lot of talk this week about how 'the great bond bubble' is about to crash and that equities look attractive compared to them. One data point that commentators have been citing is that the Dow's dividend yield is now greater than the 10-year Treasury bond yield. We've heard some say that this is the first time this has happened in decades, but in actuality, the Dow's yield got much higher than the 10-year bond yield as recently as late 2008 and early 2009. Bespoke presents a chart Dow yields minus 10-year Treasury bond yields from 1920 to the present.

There is no shortage of reasons to believe that the environment for stocks is weak, if not outright dangerous. Debts and deficits, for example, have climbed to record proportions. Consumers are learning what 'austerity' means. And governments in developed markets are acting as if they can continue to delay enforcing real, sustainable improvements. Maybe these real world concerns will matter this autumn, when stocks are historically very vulnerable. But the world's troubles seem to have little meaning to the summer campers.

The housing bubble is slowly winding down and inventories are being worked off. The stock market has recovered half of its losses since February 2009, while corporations have cleaned up their balance sheets, increased productivity and stand ready to expand. Consumers have cleaned up their debt and increased their savings. The government can now lead us out of a slow growth economy by cutting spending dramatically and keeping the tax cuts in place.

The August 6 report from the Federal Reserve on consumer credit and indebtedness depicts consumers and households that are still in the throes of a difficult deleveraging process. In the longer term, this is exactly what is needed to help put the U.S. economy back on a solid foundation for recovery and renewed growth. Because deleveraging involves two steps, however - first, avoiding spending based on new borrowing, and, second, directing current discretionary income toward debt repayment rather than consumption - it limits how much consumers can contribute to the recovery.

For those that haven't checked the odds for the November elections over on Intrade.com lately, the odds for Republicans to win control of the House have jumped all the way up to 61 percent. At the start of 2009, the odds for Republicans to win were at just 15 percent. From mid-March to mid-June, odds for control of the House hovered around the 50/50 mark. Since mid-June, however, traders have been betting big on Republican control. At this point, we have to assume that the market is 'pricing in' a Republican victory.

What appears to be a preliminary trend in declining rates of GDP growth has led many to speculate that the current economic recovery is weakening, or that we are slipping into another recession. The latter scenario seems very unlikely given the number of simulative factors at work in our economy, such as record-low interest rates and record-high deficit spending by the federal government. But the fact that we are less than three months away from an important midterm election in the U.S. Congress means that the state of our economy will be hotly debated and in the headlines.

The U.S. trade deficit increased to -$42.3 billion in May. Large and increasing trade deficits are sustainable as long as the rest of the world is willing to lend money to finance them. Growing trade deficits, however, are unhealthy in the long term. Trade imbalances also cause imbalances in capital flows. There was a time when it was argued that, as the U.S. entered a post-industrial society and economy, its growing trade deficit in goods would be offset by a growing trade surplus in services. Nearly three decades of experience, however, have demonstrated that this isn't the case.

A combination of sharply declining tax revenues and a surge in stimulus and bailout spending, both stemming from the financial crisis, caused the federal budget deficit to soar to almost 10 percent in 2009. Total debt to GDP ratios are climbing sharply, and could pass 90 percent by next year. The growth track of entitlement programs has led many to conclude that growing federal debt levels are unsustainable in the long term. Additionally, the Greek debt crisis could trigger increasing awareness of sovereign default risk with investors demanding higher rates for owning government debt.

Many practitioners of core/satellite investing use the core of their clients? portfolios to generate market-like returns with market-level risk exposure, or beta, and use satellite investments to produce excess returns, or alpha. Within this framework, passive investment vehicles ? index funds and ETFs ? have become standard core investments. First Eagle questions this approach, and believes an actively managed global portfolio should be the core.

The equity and fixed income markets are still modestly overvalued. In addition, the economic recovery may only have been a mirage that the slow dwindling of the government stimulus will reveal. The majority of Grey Owl's equity portfolio is made up of 'high quality' companies ? those with consistent earnings growth and low financial leverage. Japanese-style deflation and 1970s-style stagflation are both possible given the slow private sector growth, increasing government regulations, growing government debt loads, and expansive monetary policy.

While labor market data indicates the economy is still adding jobs, the pace of additions is far slower than what is needed to meaningfully reduce our 9.5 percent unemployment rate. Much of the half-a-percentage-point rise in employment during the second quarter of this year came from the hiring of up to 700,000 temporary workers for the decennial Census survey. Now that this effort is winding down, some economists are forecasting that short-term unemployment will rise again.

It is unlikely that the Federal Reserve will soon reverse its easy-money policies amidst worries about the European government debt crisis, meager job growth and low inflation in the U.S. In light of all these concerning developments, Osterweis continues to take a conservative approach by focusing on securities that will experience less volatility in the current unpredictable environment. These include short duration bonds and certain 'cushion' bonds, which are longer-term, high coupon bonds that will likely be refinanced in the near term, well in advance of their maturities.

The economy is not headed towards a serious double-dip recession, but rather towards a slowdown or moderation of its growth rate. That is, the economy has been improving, just not as fast as investors envisioned earlier this year. Osterweis is therefore staying the course, focusing on solid companies with strong or improving balance sheets and a history of stable or growing dividends. They are also keeping some cash as a buffer against further erosion in the overall market and as a buying reserve to use when compelling bargains emerge.

Global economic activity is improving, but significant headwinds remain, particularly within the developed world, where mounting sovereign debt threatens long-term economic gains. So far, government responses to the crisis have varied, and this lack of coordination may lead to divergent economic performance in the year ahead. Emerging markets have held up relatively well, primarily because they have managed their economies frugally throughout the past several years. Globally, corporations are generally enjoying expanding profit margins, while balance sheets remain solid.

The American public and many members in Congress are waking up to the fact that Keynesian economics is not working. It did not work in the 1930s either, as we actually had a recession within the depression, and suffered double-digit unemployment throughout the decade. This time can be different if the public demands and Congress enacts legislation that will lift the veil of uncertainty and help build a more conducive environment for establishing new businesses and creating new jobs in existing businesses. Then money would come out of hiding and get this economy moving again.

One thing is certain - there is a lot of bad news around and many people are now forecasting a double-dip recession. 'Bad news,' however, may already be factored into prices. Global growth is still expected to be solidly positive in 2010 and 2011, albeit somewhat skewed to the emerging markets. Corporate balance sheets are very robust, productivity has never been higher and earnings growth remains strong even on somewhat reduced estimates. Equities should therefore offer significantly better returns than bonds or cash.

The muni market sky is not falling. Municipal credit downgrades and defaults are indeed likely to increase in the months ahead, even as the U.S. economy regroups and moves forward. It may seem odd that muni credit quality faces continued challenges at a time when businesses and other sectors of the economy are going ahead, but that's just an unfortunate feature of a lagging market, one that municipalities share with the labor market. In the long run, municipal bonds as an asset class still have credit quality second only to U.S. Treasury bonds.

There's been lots of movement on the Intrade contracts for where LeBron James will end up, on the eve of his announcement. As Bespoke shows in charts provided, the Cleveland contract has dropped significantly while the New York Knicks contract has spiked this evening. News that he'll be making the announcement from Greenwich, Connecticut instead of somewhere in Ohio seems to be what shifted the odds.

Whether bullish or bearish, the rapid growth in corporate liquid assets does reflect one undisputable fact: The corporate sector of the economy generally responded quickly and effectively to the Great Recession, cutting costs, shedding excess inventory and curtailing unnecessary investments. As a result, corporations are poised to perform well based on the overall strength of the current economic recovery. Earnings growth over the past five quarters has been impressive. However, whether this trend and rate of earnings growth can continue will increasingly depend on what happens to revenues.

With Spain and its PIIG friends continuing to cause anxiety in global investment circles, it's a good time to focus on the potential risks and rewards facing investors right now. In reviewing our commentary released on February 1st of this year, we find that little has changed in the reward/risk tradeoffs we see. Themes identified earlier this year are now starting to play out and come into focus, as often happens simply with the passage of time. So, here is a brief update on those themes and more importantly, how they are influencing the management of the portfolios we run.

The decline and collapse of GM was a long-term phenomenon and not that uncommon a story for corporations in the history of U.S. business, except for its sheer size and (perhaps) the length of time over which it unfolded. One after another attempts to salvage the company fell short of expectations. Why GM failed?and why other companies in similar situations have managed to execute successful turnarounds or avoid collapse is an important question.

Remember back in April when the yield on the ten-year was approaching 4 percent and everyone seemed to be worried that the era of low rates was over? That didn't last long. Less than three months later, the ten-year yield is not only lower, but it's also on pace to close today at a 52-week low of 3.14 percent Since April's peak in interest rates, there has been no shortage of concerns popping up regarding Europe and the strength of the US economy.

India was not severely impacted by the global economic recession and the country is projected to grow rapidly over the next decade. For investors, a consumer-based Indian economy holds positive implications because many global companies view potential Indian demand as a ticket to future growth. Indeed, India's is one of the biggest and fastest growing consumer populations in the world. Nevertheless, the government's inability to keep building infrastructure and power generation and tackle core problems in education, land reform, corruption and social reform may temper growth.

With gold trading at a record high, we wanted to highlight the shifting correlation between it and the US Dollar. Normally, when gold rallies, the dollar declines and vice versa. However, as the chart below illustrates, gold and the dollar have become increasingly unlinked. In the chart, positive readings close to one indicate a strong positive correlation, while readings closer to negative one indicate a strong inverse correlation. The current level of -0.18 indicates a very weak inverse correlation.

Investment-grade bonds are likely to generate average returns in a 1 percent to 2 percent range in most scenarios over the next five years. That is markedly lower than any historical rolling five-year average annual return number since the mid-70s. Forward-looking scenarios project that bond yields and inflation higher than their current levels and capital losses due to rising yields will cut into income from coupon payments.

Traders on Intrade are currently putting the odds of BP's Tony Hayward to depart as CEO by the end of the year at 59 percent. How about Goldman Sachs? The last trade on the contract for CEO Lloyd Blankfein to depart by the end of the year puts the odds at 20 percent. Odds for Goldman to pay a fine of at least $25 million to the SEC by the end of the year are at 80 percent. The November elections are being heavily traded on the site. Odds for the Republicans to take back the House of Representatives in November are at 47 percent.

Now that stocks are suffering a bona fide correction this quarter and Treasury yields are again pricing in low inflation expectations in the near term, the case for a long, slow, grinding economic recovery with continued low interest rates for months to come is a lot easier to make than it was seven weeks ago. Money market and FDIC-insured accounts should provide the most predictable path with the least price fluctuation. Investors who want more yield and return should consider high-quality short-maturity bonds and bond funds.

Former hedge fund manager Keith McCullough compares America's current situation to Lehman in 2008 in that it is borrowing short to fund long-term liabilities. We can see the effect that high sovereign debt is having in Europe, and the U.S. is heading down a similar path. U.S. debt as a percentage of GDP is already higher than that of troubled Spain. Analysts have warned that higher taxes alone will not be enough to solve America's debt problem. Reduced government spending is needed and higher inflation may be unavoidable.