Investors began 2003 worried about the possibility of a double-dip U.S. recession. Very weak economic news from January through March offered little encouragement. Equally unsettling was the geopolitical roller coaster occurring during the year’s first few months (Iraq, SARS, North Korea, etc.), but hopes rose as the second quarter began due to significant improvement in news on Iraq and SARS.

Questions about the health of the global economy remained unresolved for the second quarter in a row. In the U.S., despite robust housing markets and refinancing opportunities across much of the country, consumer sentiment remained soft, and consumer spending news was grim. Data releases such as retail sales and personal consumption expenditures confirmed that the trend in spending was well below where it typically is early in an economic recovery. Reports on business spending were also discouraging. Low inventory levels notwithstanding, most measures of capital spending (durable goods and industrial production, for example) were weak. The widely tracked “Institute for Supply Management Manufacturing Business Survey” reported continued weak activity, citing weakness in many sectors, pressure from natural gas prices, SARS concerns in Asia, and the impact of a declining dollar. Manufacturing employment has declined for 35 consecutive months and has shed 2.6 million jobs, or 15% of its total.

Conditions were also uncertain outside of the U.S. The International Monetary Fund noted that any economic recovery in Europe would likely be postponed because of a lack of structural reform, high corporate debt, a stronger euro, and the aging population. Additionally, most economists believe that Japan’s economy continued to idle during the second quarter.

About three months ago, in mid-April, we wondered why the hoped for “bounce” in stock prices had dissipated after only a few strong weeks of upward prices in spite of quite positive news about the Iraq war. Nonetheless, we thought that stock prices were about right given continuing economic weakness, challenges to company profitability, and the ongoing threat of global terrorism.

This past quarter again offered evidence that stock markets hate uncertainty. The resolution of a large block of uncertainty about the duration and outcome of war in Iraq lifted a huge weight off valuations. So as it turned out, the initial bounce was only pausing in late March and had higher to fly. Since mid-April, in less than three months, the U.S. market has climbed a further 14%-23%, depending on which measure you choose, and foreign stocks are up similarly (data are as of this writing). As mentioned above, this very large move has benefited from not only significant reduction in geopolitical uncertainty, but also concurrent governmental economic stimulus. It also comes on the heels of a three-year global bear market which brought down equities’ prices significantly (the broad market) and even dramatically (technology and telecommunications), which attracted buyers. Finally, recent reductions of tax rates in the U.S. are not only putting more dollars in our pockets; they are also increasing the attractiveness of stocks by reducing the tax rate on capital gains and most common stock dividends. The higher after-tax cash flows justify higher valuations.

To summarize the case being made by the bulls, they say the market is not merely responding to the relatively quick end to the major hostilities in Iraq; it also is foretelling a marked upturn in the global economy. Convinced that all the bad economic numbers are backward looking, the bulls maintain that the best indicator is the market itself. Finally, the bulls note stock market rallies can become self-fulfilling by raising consumer and corporate confidence, thus stimulating the economy and corporate profits.