What Has Changed

* Equity markets, though volatile, have begun exhibiting underlying resilience, despite the outpouring of unfavorable economic and corporate news.

* President-elect Obama pledged to revive the economy and create jobs by making the single largest new investment in infrastructure since the Eisenhower administration.

* Interest rates on short-term Treasury bills briefly turned negative, reflecting year-end funding concerns, risk aversion and continued stress in credit markets.

* China's economy is slowing abruptly, increasing fears of rising unemployment and capital flight.

Recent Data Suggest a Near-Term Decline in U.S. Economic Activity Greater Than Our Relatively Pessimistic Expectations

* Employment, sales and trade indicators imply an annualized contraction in fourth-quarter gross domestic product (GDP) exceeding 6%.

* Households are likely to increase savings as declines in equities and house prices have significantly reduced wealth.

Federal Reserve Continues to Use Its Balance Sheet Boldly to Improve Liquidity and Get Credit Flowing

* Recently announced programs to help consumer credit and mortgage markets could push the Fed's balance sheet beyond $3 trillion.

* The Fed is considering seeking Congressional approval to issue sterilization bonds, enhancing its ability to increase lending and asset purchases without losing control of interest rates.

* Private sector buyers appear to be returning to the commercial paper market, which rose $48.6 billion during the week ending Dec. 12.

* Financial institutions reported sharp increases in level-three assets (hard to value, hard to sell), suggesting potentially large writedowns in the fourth quarter.

Equity Markets Require Greater Visibility of Economic and Earnings Recovery Before a Rally Can Be Sustainable

* Riskier asset markets remain plagued by liquidity and credit concerns.

* The earnings outlook continues to weaken, and companies are aggressively cutting inventories, payrolls and capital spending.

Developing Countries Face Sharpest Growth Slowdown Since World War II, as Trade Contracts and Capital Flows Plunge

* Chinese exports dropped 2.15% in November, the first year-over-year decline since early 2002.

* Sterling fell to a record low against the euro, as the U.K. economic contraction accelerated and further interest rate cuts by the Bank of England appeared likely.

* Japan's GDP declined significantly more in the third quarter than previously thought, highlighting the need for fiscal stimulus to boost domestic consumption.

* Trends in employment, consumption and investment in the Eurozone indicate a deepening recession.


* Markets are increasingly resilient and experiencing more short-term rallies. This is part of the base-building and bottoming process that should eventually lead to a new bull phase. But more unsettling economic and corporate news is coming, and it's still too early to call an end to the bear market. We would maintain defensive portfolio strategies.