UNEDITED!

The past couple of weeks have witnessed some severe swings in investor sentiment. At the beginning of the month, investors were thinking that the economy might be overheating. That was diminished by the March employment report. By the end of last week, investors were worried that the economy entered into another "soft patch" in March. This week investor breathed a sigh of relief after producer prices showed that inflation appeared contained. This lasted a full day until the consumer price index rose more than expected and the Federal Reserve's Beige Book added anecdotal evidence that pricing pressure is working through to the end user. Not only do investors have to try to figure out a convoluted macroeconomic backdrop, but companies are reporting first quarter earnings as well. At this point, corporate earnings and future guidance has only addedto the confusion surrounding the markets.

Producer prices rose 0.7% sequentially in March and increased 4.9% from last March. While this was above economists forecasts, excluding food and energy producer prices rose only 0.1% sequentially and 2.6% year-over-year, both lower than forecasts. The lower increase in the core eased concerns about rising inflation. Economists assumed that companies are not able to increase prices to offset their rising costs, thus containing inflation. This sense of relief was dashed on Wednesday after the Bureau of Labor Statistics reported that the consumer price index rose 0.6% from February and 3.1% from a year ago. Excluding food and energy, consumer prices rose 0.4% in March, the largestincrease since August 2002 and higher than the 0.2% increase economist expected.

Inflation fears were further fanned Wednesday afternoon after the Federal Reserve released the Beige Book. The report that details the health of the economy from mid-March to April 11, revealed that "Price pressures have intensified in a number of Districts, and most report that high or rising energy prices are a concern across sectors." The report also weighed in on whether the economy hit a "soft patch" in March. The compilation of comments from across the country describes an economy that continued to expand over the past month, but perhapsa little slower than earlier this year.

Consumer spending was described as "solid" in most of the districts, but three districts (New York, Chicago, Dallas) said retail sales were "subdued or disappointing." Weather and high energy prices were cited as reasons for the lackluster spending. Several districts reported that car buyers shifted away from domestic vehicles andespecially trucks and SUVs.

The industrial side of the economy continued to show positive attitudes. All but one district reported that production rose over the period. But, several of these districts noted that growth was moderating. Manufacturers in all the districts said that they were "facing rising costs for a variety of inputs, most notably energy, transportation, petrochemicals, and other petroleum-based products." Additionally, "most districts found that firms were having partial success passing on higher energy and materials costs to their customers." There were also some reports of price increases not being able to pass through andhad to "accept lower margins."

Residential construction remained one of the strongest parts of the economy. Three-quarters of the districts reported that "demand for houses was strong." Only Dallas and St. Louis "noted slower residential construction." The commercialreal estate market was more mixed.

First quarter earnings season got in full swing this week. 65.3% of the 147 companies in the S&P 500 beat analysts' estimates. First quarter earnings now appear to have increased by 12.0%, compared to 7.6% at the beginning of the quarter and 8.2% at the beginning of April. As good as first quarter earnings appear, investors are more concerned with the outlook for the second quarter and the rest of the year. Unfortunately, companies are not nearly as optimistic going forward. While it is a small sample, there have been 25 S&P 500 companies that have updated guidance for the second quarter and 64% of them have lowered guidance with only 20% rising guidance. This compares with 31% lowering guidancelast year and 48% last quarter.

Several of the major homebuilders reported earnings this week. DR Horton reported earnings that were ahead of Wall Street forecasts. Average new order price increased 15%, largest increase since the first quarter of 2003. ARMs accounted for 33% of originations with 25% of those interest only mortgages. New orders increased 7% on a unit basis and 23% on a dollar basis. This increased the backlog by 17% and 33% respectively. Results from MDC Holdings were similar. Earnings were 35% better than a year ago. The company did reduce expectations for the second quarter due to weather delays in the Western part of the country. The results of MDC did raise a few concerns with analysts. The percent of ARMs was quite a bit higher at 45% with 75% of those being interest only. Plus, the number of new orders in California dropped by 35%, and its cancellation rate rose to 20.2% from 18.6% last year. However, prices in California rose 34%. The company did say that it saw more investor activity in Las Vegas andPhoenix.

In light of these results, the nation's homebuilders were a little less optimistic in April. The NAHB Index dropped 3 points and was the weakest since September 2004. Last September was also the last time the index fell by at least 3 points.First time the index has shown a year-over-year decline since May 2003.

Obviously, the big earnings debacle was General Motors. Investors were clearly looking for a detailed plan to fix North American automotive operations. Instead, investors heard the same refrain of product development and cost cutting. On the conference call, one analyst pointed that that its competitors are also working on new products and "the math doesn't seem to work" since GM cannot do enough on the labor side to get to breakeven. Additionally, management withdrew future guidance because of "uncertainty in industry forecasts and ongoing health care issues." Without spending time on Ford, it cut second quarter productionby 5%.

During the conference calls several companies mentioned that the second half of March was weaker than the first half. While Easter occurred in March this year, most companies were not blaming the holiday shift for the slower activity. One of the more notable examples of business activity declining throughout the quarter was from Manpower. The leading employment staffing company said that its US staffing business in January increased by 4.1%. Growth slowed in February to 3.0% and dropped to 0.5% in March. Additionally, the company saidit has not seen anything indication that activity picked up in April.

The earnings season is still young, but preliminary results indicate that sales and earnings were robust in the first quarter, but started to slow down as the quarter progressed and March was the weakest of the first three months. It should also be noted that the economy was booming last year and slower growth should be expected. This slower growth, however, should not be translated into a weak economy. It is difficult to characterize the economy as weak with companiesreporting component shortages and distribution bottlenecks.