The solid economic expansion that remains in place has faced a number of challenges since its inception. In the face of this adversity, the broader markets have remained resilient. Since the outset of the year, higher commodity prices, energy costs, and a rising interest rate environment established the headwinds currently faced by the markets. Most recently the natural disaster in the Gulf States region from hurricanes Katrina and Rita caused the loss of life, the destruction of homes and businesses, and the disruption of one of the nation's key port infrastructures. The true impact of this disaster remains to be seen. However, the initial data points indicate that broader economic growth will continue, and there are reasons to be optimistic.

Key Economic Growth Variables:
In the past, we have discussed three critical components of the overall economic environment: Consumer, Corporate, and Government spending. The strength of consumer spending is well documented over the last few years and with the current energy price environment, the consumer's resolve will be tested.

Government spending, in the wake of hurricanes Katrina and Rita will be unprecedented as the rebuilding process begins and infrastructure needs are met. Hundreds of billions of dollars will be allocated to the disaster relief in addition to the budgeted outlays for Homeland Security and the federal government's pledges of support to entire industries. This level of spending is likely to stimulate broader economic activity. Consequently, the government's fiscal and monetary policy actions remain an extremely important driver of overall economic growth.

Corporate spending remains the most critical aspect of the spending equation. At the outset of the year, we discussed how corporations failed to do their part in stimulating economic activity as higher profitability was achieved over the last several years. The delay of expansion activities, the paring back of expenses, and a reduction of inventory levels resulted in a lack of capital spending that kept the lid on one of the most dynamic drivers of economic activity. A careful review of Capital Expenditures indicates that corporations are starting to deploy their sizable cash balances even though the rate of corporate earnings growth, while positive, could moderate. We view this as extremely positive, since it signals the fundamental health of corporations as well as the fact that these business entities have money to spend on expansion and growth-related activities.

Impact of Hurricanes:
Inevitably, there will be a short-term economic impact from this natural disaster. The broader impact will depend on the damage to the Gulf region's infrastructure. The petrochemical industry and shipping infrastructures play a critical role in our domestic economy. Agricultural products, raw materials, and finished goods all flow through the Port of New Orleans and the length of downtime will have a direct impact on the overall economy.

Employment in the Gulf States region will suffer, as tens of thousands of workers have been displaced and a countless number of businesses have been destroyed. For those surviving businesses it could take weeks or months to bring their operations back on-line. However, the large-scale rebuilding process will require resources of materials, dollars, and human capital, which will create new opportunities for companies and individuals that remain in the region.

Interest Rates:
The Federal Reserve continues to play an integral role in shaping the market environment, as they remain focused on controlling inflationary pressures through their interest rate increases. We continue to believe that interest rates will gradually rise. As we identified in our previous Investment Perspective, an unusual situation has developed through the current series of rate increases. Long-term rates have not risen but actually declined modestly, which has dramatically flattened the yield curve relative to where it was 12 months ago. In the aftermath of hurricanes Katrina and Rita, if inflation pressures mount, the Federal Reserve is likely to continue raising short-term interest rates as they move through this tightening cycle.

Energy and Commodity Costs:
Energy prices and commodity costs continue to dominate investor discourse, specifically as they relate to the cost of raw materials and other input costs. A large component of the increased energy costs is related to strong international and domestic demand. However, increased global demand for energy resources of all types has strained refining and production capacity. Further compounding the challenges is the disruption of capacity in the Gulf of Mexico from hurricanes Katrina and Rita. While this is a short-term supply disruption, it does have consequences that will filter through the system. Higher sustained oil prices could act as a damper to overall economic growth by impacting both consumers and corporations.

Energy prices that remain unusually high for extended periods of time tend to force market participants, both consumers and corporations, to make critical spending decisions. It is well documented that high energy prices act as a tax on the consumer by effectively reducing the amount of disposable income they have to spend on goods and services. Consumers are forced to make spending choices in this type of an environment, which could directly impact those companies responsible for providing those goods and services.

Corporations are not immune to higher energy costs. As input costs rise, unless they pass these increased costs on to the consumer through higher prices, their profit margins will come under pressure and earnings growth could slow. Consequently, the investment community is intensely focused on the energy and commodity environment and its impact on overall economic growth.

Outlook:
Our fundamental economic work confirms our positive stance on stocks, and our asset allocation tools indicate that currently common stocks present more attractive investment opportunities than bonds. In times that are filled with uncertainty, it is challenging to maintain a positive outlook and it is easy to become caught up in the negative rhetoric and the emotions of the day. As investors, we are continually challenged to apply realistic expectations regarding the meeting of investment objectives. Viewing the economic environment, the broader markets, and the individual market participants from a macro perspective as well as adhering to a long-term investment strategy, investors will be better positioned to achieve their investment goals and objectives.