2012 is likely to feature a slow-growth world that includes a recession in Europe. The US faces headwinds, but manages to achieve growth of between 2% and 2.5%. China and India slow somewhat, but, along with the US, make up two-thirds of global GDP growth. The big risk remains that of a financial breakdown in Europe, which would tip the developed world into recession. Inflation should also continue to move lower. Should the muddle-through environment come to pass, we believe earnings and some improvement in confidence would allow equity markets to move higher, with US stocks leading the way.

Although 2011 started off on a relatively strong note for the global economy and markets, the past year was dominated by fears that contagion from the European debt crisis would derail the recovery. Overall global economic growth struggled as most areas of the world experienced growth slowdowns (the notable exception being the U.S.) Emerging markets were also faced with some mounting inflation pressures, which presented a challenge for policymakers. Although there have been some signs of progress regarding the debt crisis, uncertainty levels remain high going into 2012.

Market action last week centered on the European summit that took place on Thursday and Friday. While no one is suggesting that the debt crisis will go away any time soon, the framework agreement that was reached has at least reduced some of the anxiety and appears to have eased the gridlock in European financial markets. While these moves will do little to ease the near-term debt issues affecting many European countries, they are important. In our view, last week's summit may well represent the first tangible positive developments since the crisis began.

Although last week's news was positive it is too early to declare any sort of victory and it is important to remember that the market gains that occurred last week did not match the losses of the previous two weeks. However, it does appear that conditions are continuing to improve. The coordinated rate action and continued easy availability of money should ease some of the world's debt burdens. On the economic front, we are expecting GDP growth in the US to increase to at least 3% in the fourth quarter, which should provide further evidence that the macro backdrop is getting better.

Equity markets sank sharply last week as the European debt crisis worsened and the US super committee failed to come to an agreement. Congress still has an opportunity to address deficit reduction, but of course the fact that all of this is occurring with the backdrop of the 2012 elections means that uncertainty levels are elevated. As a result, unless and until more clarity emerges, markets are likely to remain somewhat trendless in the near term.

Notwithstanding last week's market setback, conditions have improved noticeably over the last couple of months. In late summer, many were predicting that there was a greater-than-50% chance that the US would sink back into recession, Europe was on the verge of falling apart and there were widespread fears of a hard economic landing in China. Today, it is growing more clear that not only has the US avoided a recession, but it is actually showing signs of growth acceleration, Europe is showing signs of progress (although much more needs to be done) and China appears poised for a soft landing.

We do not think the Fed is quite ready yet to enact QE3, but should we see some sort of combination of further chaos in Europe, inflation levels receding further and economic growth deteriorating, the likelihood would grow. On the economic front, last week saw the release of the October payrolls report. Gains were slightly weaker than expected (up 80,000), but the data also showed that gains in August and September were revised up sharply and that unemployment fell very slightly, from 9.1% to 9.0%.

Investor sentiment has certainly improved over the past several weeks, and while it is much too early to declare victory over the European debt crisis, last weeks deal is certainly a positive step. The easing of the risks associated with Europes issues, along with a brighter outlook for the US economy than was the case a couple of months ago does create a more solid footing for risk assets. Given the sharp advance markets have seen over the past month, we may be in for a period in which markets need to "digest" these gains, but the longer-term outlook for stocks does appear to be improving.

S economic data has shown some encouraging signs in recent weeks. Retail sales figures and jobs indicators have trended to the positive, which has caused a number of economists to upgrade their forecasts for third- and fourth-quarter gross domestic product growth. The overall sense of economic uncertainty remains high, but it is looking increasingly likely that the United States will avoid a double-dip recession.

For the second consecutive week, stock prices moved sharply higher as investors welcomed the news of progress in addressing the European debt crisis and also took some solace in improved US economic data. For the week, the Dow Jones Industrial Average climbed 4.9% to 11,644, the S&P 500 Index advanced 6.0% to 1,224 and the Nasdaq Composite jumped 7.6% to 2,668. Other risk assets, including commodities, also experienced gains last week, while safe-haven assets such as US Treasuries struggled.

It is difficult to assess value in the current environment. If the European debt crisis were to suddenly disappear, stocks would appear very cheap, but of course the uncertainty over the debt crisis remains the critical wildcard. From a technical perspective, over the past couple of weeks the S&P 500 tested the 1,100 low it reached in August and while that level was briefly pierced from a price perspective, stocks rebounded quickly which perhaps makes the 1,100 level a stronger floor. This is not to say that that level will not be tested again, but we do believe it is a good sign.

The global financial stresses that have been contributing to market volatility have shown no signs of easing. Financial markets have been signaling that economic growth levels are too weak to support the current financial structure. Corporate bond spreads in most markets have been widening and euro-area bank bond spreads are close to their 2008 crisis levels. These signals suggest that economic growth needs to improve sharply (which is not likely to happen any time soon) or that further policy action is needed to ease the strain.

We expect the economy will muddle through in the coming year and we would place decent odds that economic growth will improve from the 1% level it experienced in the first half of 2011. This view is predicated on the assumptionand it is a big onethat there is no major additional fallout from the European debt crisis.

In contrast to Europe, the United States economy remains in reasonably good health. The United States does, of course, have its own sovereign debt issues to deal with and the future state of the federal deficit is an obvious source of concern. The difference between the United States and Europe is that the United States has the ability to solve its own fiscal problems, even if coming to an agreement about how to do so is a significant challenge. Given this backdrop, its hardly surprising that US stocks have been outperforming on a relative basis over the past couple of months.

We are in the midst of a bear market in confidence more than anything else and investors should be on the lookout for signs that conditions will be getting better. There are a number of developments that could help restore confidence. Positive surprises in US economic data; lower interest rates in Europe; major European bond purchases; a eurobond issue; additional quantitative easing from the US Federal Reserve; the US Congressional super committee agreeing to major long-term entitlement reform; and US pro-growth tax policies that encourage capital formation.

The U.S. will avoid a deep slump, but it remains an open question as to whether growth is modestly positive or if the US flirts with a recession. In any case, however, we do not expect to see a period of economic weakness that is anything like what we saw in 2007 and 2008. Unlike then, the US financial system is much better capitalized, the housing market is no longer overvalued and there is some demand in the cyclical parts of the economy. Additionally, we would point out that temporary factors are at least somewhat responsible.

In some ways, whether or not the economy does sink into recession is a technical point. If we do see a double-dip recession, any such contraction should be mild. If the economy avoids a recession, growth will still be weak. From an earnings perspective, any decline that comes about in earnings growth due to economic weakness should also be smaller than the average contraction that occurs during a typical recession. Looking ahead, our forecast is that earnings growth flattens out while GDP remains very low.

Despite the overall negative tone among investors, not all of the news has been bad in recent weeks. Data regarding July pointed to the beginnings of a stronger economic second half of 2011, including better payroll figures, industrial production, unemployment claims and retail sales. Additionally the Index of Leading Economic Indicators actually rose in July and was ahead of expectations. However, it is important to remember that August is when all of the stresses in the credit markets and equities spiked, so it is very possible that this may negatively impact Augusts economic statistics.

We believe investors are overly pessimistic about the possibility of a renewed recession in the U.S. It is important to remember that equity markets have a poor track record as acting as predictors of recessions and corporate fundamentals remain strong. Since 1950, the U.S. has never entered a recession with corporate balance sheets as flush with cash as they currently are-at present, nonfinancial companies are holding cash in the amount of around 11% of their balance sheets, the highest level in over 60 years.

A review of some of the data provides valuable perspective on the recent extreme market volatility. The recent weeks correction has taken US equities down about 18% from their April high. About 11% of that decline has come in the past three days. In comparison, when equity markets began to price in a double-dip recession last summer, US stocks fell 17%, a decline of virtually identical magnitude. Following sharp reversals of this sort, we have in the past seen the market quickly recover 33% to 50% or more of its losses.

Two weeks ago, we did not think that stocks were expensive. Now, with markets lower by 10%, stocks are pricing in a more negative scenario than we expect. To us, this suggests that the present market could represent an opportunity to accelerate moves out of cash and Treasuries and into risk assets.

Over the past several months, stocks have been in a fairly narrow trading range, with strong earnings pushing prices higher and macro risks and the growth slowdown acting as counterweights. Once the debt and deficit pictures become more clear and once investors are able to price in the effects of the final deals, markets may be able to again focus on fundamentals. From an economic perspective, the US economy remains vulnerable, which is not a comfortable backdrop for risk assets, but we continue to believe that the probability of recession remains low and that economic data should improve.

Thanks to a new agreement to at least temporarily resolve the Greek debt crisis, some intermittent progress on the debate over raising the US debt ceiling, and strong corporate earnings results, stocks posted solid gains last week. Despite all of these debt-related risks, global indicators are not signaling a recession. One area of significant strength remains the corporate earnings landscape. We have also been seeing a rebound in industrial production and consumption. There are certainly areas of economic weakness and uncertainty remains high, but we expect to see stronger growth levels.

In addition to heightened levels of unease over the sovereign debt crisis in Europe and escalating noise over the debt ceiling in the United States, market volatility has been driven by uneven economic data. While the economy is in a recovery mode, it is important to remember that recoveries that occur in the aftermath of financial crises tend to be bumpy and slow. If we were in the midst of a normal recovery, real US GDP growth should have averaged around 6% over the last two years. It has averaged less than half of that. For the first half of 2011 will have expanded at a less-than-2% pace.

At the halfway point of the year, we thought it would be appropriate to look at the predictions we made at the beginning of 2011 to see where we stand. 1. US growth accelerates as US real GDP reaches a new all-time high. US real gross domestic product growth reached a new all-time high in the first quarter of 2011, so we have already gotten the second half of this correct. The first half will be dependent on the degree to which the US economy is able to accelerate in the second half of this year. 2. The US economy creates 2 million to 3 million jobs in 2011 as unemployment falls to 9%.

Last week the Fed elected to keep interest rates on hold. The central bank has downgraded its assessment of US economic growth. The Fed did, however, underscore that the factors causing the weakness were mostly temporary, highlighting higher fuel and food prices and disruptions from the natural disasters this year. We are not expecting to see any near-term changes in the Feds position and we think there is virtually no chance of a QE3. Conversely, given a slow recovery and a subdued inflation outlook we are not expecting to see higher interest rates until at least mid-2012.

There is no shortage of things to worry about, an environment that has caused stocks to move in a sideways pattern for close to two months. Investor anxiety and market volatility levels will remain elevated for the time being. At some point, stock valuations will settle at a level where investors feel adequately compensated for the downside risks facing the market. We are retaining a constructive view toward the economy and the markets and we suspect such a valuation level is not too far away. Investors should view the current period of weakness as an opportunity to take on additional risk.

A key difference between the 2010 correction and what we are seeing now, however, is the degree of the downturn. So far, equity markets have fallen only about half as much as they did last year. This comparison, of course, leads to the question of how much further the current correction will run. In our view, the answer will be largely determined by the degree to which the economy will either accelerate or decelerate, and while the current economic data continues to be weak, we are expecting to see a rebound in the third quarter of this year.

A stream of increasingly disappointing economic data helped accelerate the multi-week correction in stocks. The most recent high-profile evidence pointing to a slowdown in growth came in Fridays jobs report for May. For the month, total nonfarm payrolls grew 54,000 (consensus expectations were for over 150,000). Additionally, the unemployment rate unexpectedly rose to 9.1%. There has clearly been a soft patch in economic performance this spring, and as such, the employment growth rate is slowing rather than accelerating. In addition the ISM Manufacturing Index for May dropped sharply.

Economic data has continued to come in on the weak side, which caused stock prices to slide yet again last week. In our opinion, some of the recent weakness in economic data can be attributed to temporary factors such as the spike in oil prices, the natural disasters in Japan and flooding in the Southern United States. In any case, however, the soft patch in the economy has dented the pace of economic acceleration and we expect to see some continued signs of weakness in the weeks ahead, including perhaps in this Fridays labor market report for May.

The recently weaker tone in equity markets can be attributed to a broad slowdown in economic data. A longer-term retrospective view shows that the pace of economic growth has been gradually fading over the past several months. Some of the decline can be explained by seasonal factors or factors that may prove to be temporary. In any case, however, at this juncture it appears that the recovery or acceleration phase of the business cycle may be ending. We believe the economy is now shifting into an expansion mode, and the question will become how long that expansion will last.

Stock markets were flat-to-down last week as economic data continued to be mixed. In other markets, commodity prices continued to fall and the US dollar moved higher. While we do not believe that the long-term secular uptrend in commodity prices has ended, we do think that the cooling effect could be in place for some time, which will hopefully be a positive for both economic growth and stocks. Data suggests that the global economy has slowed recently, but we believe that it is still in the midst of transitioning from recovery to self-sustaining expansion.

Stocks fell last week amid a great deal of economic crosscurrents. The major story in the headlines is, of course, the death of Osama bin Laden. While the news can be viewed as beneficial from an overall perspective of improving the mood of the general public (which could have a positive impact on investor confidence), it is unlikely to have any meaningful impact on the economic or financial outlook. In our view, issues such as corporate earnings trends and economic data releases are almost certain to overshadow the impact of bin Ladens death.

Last week featured a rash of economic and earnings news as well as Federal Reserve Chairman Ben Bernankes historic press conference. All told, investors interpreted last weeks events positively, which helped stocks climb higher yet again. For the week, the Dow Jones Industrial Average climbed 2.4% to 12,811, the S&P 500 Index advanced 2.0% to 1,364 and the Nasdaq Composite climbed 1.9% to 2,874. With last weeks gains, several stock indices reached new all-time highs, while the S&P 500 Index reached its highest level since before the credit crisis erupted in the summer of 2008.

Equities remain in the broad trading ranges they have been tracing for months, but made a strong move to the top of those ranges this past week. The big news event in the US was the S&P downgrade of the US outlook, causing investors to focus on the possibility of the US government losing its AAA rating, and making it likely the budget problems will become the preeminent issue in the 2012 campaign. The looming debt ceiling vote is the proverbial bargaining chip in the middle of the chasm between the two parties on deficit reduction.

It has been a while since we have experienced two consecutive weeks without market gains. Given recent higher energy prices and some softening of economic data, however, that now has indeed come to pass. Over the last several weeks, expectations for first-quarter economic growth have been ratcheted down. Several areas of the economy have been pointing to slowing growth, including a softening of business spending on equipment and software, a slower-than-expected rise in inventories, weakening trade data and contracting construction activity for both the residential and nonresidential sectors.

The preponderance of the economic and market-related news skewed to the negative last week, with an additional earthquake in Japan, rising oil prices, an interest rate hike by the European Central Bank (ECB), escalating debt problems in Europe and increasing noise about the since-averted potential federal government shutdown. Despite this backdrop, however, US equities remained resilient and were roughly flat for the week, with the Dow Jones Industrial Average up marginally to 12,380, the S&P 500 Index down 0.3% to 1,328 and the Nasdaq Composite down 0.3% to 2,780.

Although markets contended with some downside risks last week, including higher commodity prices and ongoing debt issues in Europe, stocks managed to post further gains as they continued to bounce back from their recent market correction. In economic news, one of the highlights last week was the March employment report that was released on Friday. For some time now, leading labor market indicators, including jobless claims, profit trends and lending standards have been pointing in a positive direction, and we are finally also seeing impressive growth figures in private sector jobs creation.

Risk assets (and equities in particular) powered to a strong week of gains, with the Dow Jones Industrial Average climbing 3.1% to 12,221, the S&P 500 Index advancing 2.7% to 1,314 and the Nasdaq Composite rising 3.8% to 2,743. Although a number of near-term risks remain (particularly related to the unpredictability of escalating unrest in the Middle East), we maintain our view that equity markets are likely to continue their longterm trend of outperformance.

Escalating anxiety over the damage from the earthquake in Japan and resulting nuclear reactor problems as well as rising tensions in Libya and the Middle East resulted in an aggressive selloff in equity prices early last week. Despite an end-of-week rally, stocks were down for the week as a whole, with the Dow Jones Industrial Average falling 1.5% to 11,859, the S&P 500 Index declining 1.9% to 1,279 and the Nasdaq Composite losing 2.7% to 2,644. The events of the last several weeks serve as a reminder about how quickly potential risks can turn into downside reality.

Risk assets experienced a setback last week in the face of rising tensions in Libya and the Middle East. Additionally, the massive earthquake that hit Japan on Friday resulted in a sharp downturn in Japanese equities on Monday and increased investor unease. For the week, the Dow Jones Industrial Average lost 1.0% to 12,044, the S&P 500 Index declined 1.3% to 1,304 and the Nasdaq Composite fell 2.5% to 2,716. The human costs of the earthquake in Japan are obviously foremost in everyone?s mind at this time, but the potential economic and market implications are also being weighed by investors.

A tug of war is taking place in the markets, with crosscurrents of good economic reports on the positive side and a continued rise in oil prices from the conflicts in the Middle East on the negative side. Last week, US equities were up modestly, with the Dow Jones Industrial Average rising 0.33% to 12,169, the Nasdaq Composite advancing 0.13% to 2,784 and the S&P 500 adding 0.10% to close at 1,321.

Escalating turmoil in the Middle East and North Africa caused oil prices to spike higher last week and stock prices to fall. Oil prices went over the$100 a barrel mark and despite a late-week rally, stocks ended the week noticeably lower. In many ways, it could be argued that a stock market correction was overdue-before last week, the US stock market had gone 107 days before experiencing a peak-to-trough decline of 3.5%, a new record. Our long-term view is that while shortterm volatility is likely to persist, the growing geopolitical risks are unlikely to derail the global economic recovery.

The bearish view of the current rally is that it is liquidity-driven and based on artificial propping-up by overly easy monetary and fiscal policy support. While we agree that the stimulus from the Federal Reserve and other policy makers has been an important pillar in helping to restore economic growth and drive risk asset prices higher, we also believe that the economy is transitioning into a self-sustaining expansion. In our opinion, this environment of improving growth, low inflation and a supportive policy backdrop continues to represent a ?sweet spot? for risk assets.

For many investors, the shift into equity markets is still in the early stages and equity valuations are hardly stretched, suggesting that the upward moves have further to run. While pullbacks and corrections will no doubt occur along the way, we believe they should be short and shallow and should be taken advantage of to add to positions.

Although we expect some hiccups along the way, improving economic growth and corporate earnings point the way toward a continuation of the equity bull market. We are in the midst of the first global economic recovery that is being led by emerging economies, and the U.S. is only at the beginning of transitioning into a self-sustaining expansion, suggesting that economic improvements still have a way to go. As the economy improves, we are beginning to see equity market correlations fall ?stock prices are being driven more by fundamentals and less by macro factors, a trend we expect to continue.

At present, most investors appear to have increased their expectations for global growth and for growth levels in the United States. The words ?double dip? have virtually vanished from investors? vocabularies and while we agree with the generally optimistic tenor of the conversation, we are also somewhat uneasy about the positive shift in sentiment and growing sense of complacency. As last week?s events remind us, there are a number of risks to be wary of, including one we have not yet mentioned ? monetary tightening in emerging markets.

A number of factors bear close watching for investors, including the potential for additional Chinese policy tightening, ongoing weakness in the housing market and ongoing European sovereign debt issues. The overall strength of the economy, however, suggests to us that a repeat of the environment of fear that surfaced last year when the Greek sovereign debt problem developed is unlikely. We believe the strength in profit margins coupled with a less-hostile regulatory posture from D.C., should spur increased confidence, which should lead to a pickup in employment.

As we indicated earlier, we expect that the more bullish forces will prevail over the coming months, but we acknowledge that risks remain. The strong run-up we have seen since the August lows could mean that markets are overdue for a pullback, but should that occur, we would argue that any near-term weakness would be an opportunity for increasing equity positions since the cyclical backdrop is likely to remain equity-friendly.

We see a number of potential risks for the economy and the markets in the year ahead, including sovereign debt issues, emerging markets inflation and the possibility of higher tax rates, but we remain positive on the overall environment. Inflation should remain low throughout 2011, economic growth should accelerate slightly with the quality of that growth improving, and corporate earnings should remain strong an environment that should provide a solid backdrop for stocks to post further gains over the course of the year.