Editor’s Note: Mutual of America Capital Management Corporation presents the following review of economic trends prevailing in the fourth quarter of 2001. Comments reflect conditions as of December 15, 2001.

The impact of the September terrorist attacks continues to reverberate through the economy. Most indicators of activity plunged in September through October, but have rebounded to some extent. There is no question that the economy worsened during the third quarter. Gross Domestic Product, initially reported down 0.4%, was revised to down 1.1%.

Everyone seems to be casting about for signs that a recovery has commenced, and that it will be a “V”-shaped recovery. The evidence, however, is mixed. While non-manufacturing activity appears to be bottoming, manufacturing activity is still contracting. Although spending is holding up fairly well, the employment picture appears to be darkening. This tug of war will likely continue well into 2002.

The Federal Reserve (the Fed) has lowered short-term interest rates 475 basis points this year, all the way down to 1.75%. By some measures, the “real” (or inflation-adjusted) rate is now negative, and the Fed has indicated that rate decreases may be in the offing.

Stocks, usually a leading indicator of recovery, have rebounded strongly since the attacks. Longer-term bond yields, however, have risen at the same time. Higher long-term bond yields constrain economic activity, especially housing activity through mortgage rates. Housing activity has helped prop up the economy through this contraction. Typically, bond yields do not rise until well after a recovery is under way.

The wild card will be whether we can control terrorist activity and the extent of any military action beyond Afghanistan.

The stock market has recovered from the sell-off that followed September 11’s events. In the first week of December, the market had closed at levels higher than experienced in early September. Investors appear to have shrugged off economic concerns and have begun to invest in anticipation of an economic and corporate profit recovery in the second half of 2002. Their appetite for risk has increased as many stocks are moving up on anticipation of an economic/profit recovery, ahead of any improvement in fundamentals.

Corporate earnings appear to have bottomed out in the third and fourth quarters of 2001. Fourth-quarter profit reporting will be more important for the vision companies will give investors going forward than the actual fourth-quarter results themselves. For at least the past three quarters, earnings reports have pushed out any corporate profit recovery by another quarter. Consensus estimates reflect an improvement in corporate earnings beginning in the third quarter of 2002 and rising sharply in the fourth quarter of 2002. The risk is that the recovery could be pushed out yet again or not be as steep as analysts are expecting. Without a positive tone going forward, the recent run-up in the market could quickly reverse if a recovery were perceived to be delayed until 2003.

In the fourth quarter, the growth indices for both large and small cap stocks have begun to outperform the value indices, further reflecting investors’ anticipation of an economic recovery and their desire to invest in early cyclical or more “growthy” stocks. Within the sectors, technology has been performing well, along with basic materials and consumer cyclicals.

This recession is a global recession. No region has been spared from the slowdown. Europe is declining, with the region’s largest economy - Germany - officially in recession. Even the European Central Bank reluctantly cut interest rates in the face of the slowdown.

Japan is now stuck in its fourth recession in 11 years. Manufacturing activity and capacity utilization continue to decline at the same time that unemployment is increasing. The rest of Asia has been hit hard as well. Singapore’s manufacturing output is down 22%, while Taiwan’s is down 15%. Even China is hard pressed to justify its high reported growth numbers.

Many months ago, the economic situation in Argentina was clearly beyond repair, but the government kept attempting cosmetic fixes instead of real reforms. That strategy has failed, and they will be forced to undergo major changes. The banking system is on the edge of the abyss. At the rate that depositors are withdrawing money, it will be only a couple of months before the banks are completely insolvent. Markets are anticipating a major default and devaluation very soon.

Mutual of America Life Insurance Company is a Registered Broker-Dealer.