Last week the Dow Jones Industrial Average climbed 2.8% to close at 10,716, the S&P 500(R) Index rose 2.7% to 1,203 and the Nasdaq Composite added 2.5% to 2,086. The stock market rally of the past two weeks has made up more than half of what was lost in the prior four weeks for the Dow and the S&P (the Nasdaq is lagging slightly).The broader stock market also performed well last week, as the advance/decline line and the new high/new low list on the New York Stock Exchange reflected good underlying strength. In the fixed income market, bonds rallied last week following a weaker-than-expected employment report for January. The report showed that slightly less than 150,000 jobs were created during the month, as opposed to the more than 200,000 that were expected. The report also showed that unemployment fell to 5.2% in January. For the week, the yield on the 10-year Treasury dropped from 4.14% to 4.07%. Currently, the spread between the two-year and 30-year Treasury is less than 125 basis points. Despite strong fourth-quarter numbers, expectations for the first quarter and for all of 2005 are slowly receding. For the first quarter, gains are projected to be under 7%, down from the 10% projected rate from around the time of the presidential election. Projections for full-year earnings growth were at 10.7% at the start of the year and are now down to 9.9%. Our view continues to be that 2005 earnings growth will be at a rate of between 5% and 8%.

Last week also featured the president’s State of the Union address, and one of his main themes was Social Security reform, which prompted many questions about the potential impact that reform may have on financial markets. Any potential reforms would have to clear several hurdles before anything substantive can actually happen, including the budget process, tax-writing committees, and, of course, actual votes in Congress. Our best guess is that given all of the potential obstacles, there is only a one-in-three chance of Social Security reforms actually being enacted by this Congress. If, however, reforms do progress, it would mark a rare change in U.S. fiscal policy. Our view is that it would be a positive change, as proposed reforms would have the effect of reducing the tax rate on labor income, which usually contributes to economic and job growth.