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to a reduction of Government expenditure for rearmament and
foreign aid and, of equal if not greater importance, to
slackening of forward buying by consumers and businessmen.
Unlike the end of World War II, this development would
likely occur when the demand for consumer goods would net
be urgent. While a sizable business downswing of this kind
seems considerably more remote than it did prior to Korea,
we believe it should continue to be given some weight in
determining the composition of an investment portfolio. The
stock reductions made to date, in our opinion, are
sufficient protection
against this risk at this time and price level of
securities.
 
(3) A third set of possible circumstances, the one currently
most widely      accepted, is that the present condition of
international tension will       continue, although with
varying intensity. Thus, even if the Korean      campaign
reaches a successful conclusion in the near future, we     
   may well see a series of localized wars of a similar
nature. Under        these conditions, we would expect high
and expanding armament
     expenditures which, superimposed on large consumer
purchases,       should assure excellent business volume,
profits and dividends for       the immediate future.
Although accompanying controls and           taxation will
bear increasingly on all companies and industries,     
nevertheless, the sustained volume likely under these     
circumstances will enable many companies to continue to
report      good earnings.
 
     By its very nature, however, this present condition of
a heavily           armed peace is likely to be resolved
sooner or later in (a) outbreak      of war involving
direct conflict between Russia and the United      States,
or (b) reduced armaments as heavy taxation and     
burdensome controls breed widespread popular demand for
relief.      Thus in appraising the immediate prospect of
favorable volume      and profits, it is well to remember
the probable drift toward war or
     peace, either of which, as discussed in previous
paragraphs,
     would involve deflationary problems. For these reasons
we believe      it is wise to give continuing weight to the
possible temporary      nature of the present high level of
earnings.
 
                Against the background of these diverse
uncertainties, the
stock market has been strong. It is apparent that the
deflationary and unfavorable aspects of the two general
prospects, (1) world war and (2) real peace, are being
given less weight by investors than the more demonstrable,
immediate and favorable forces of (3) armed peace, which is
providing excellent profits as well covered dividends. We
do not share, however, the popular belief that rearmament
will  prolong indefinitely a good volume of business and
induce substantially higher commodity prices (inflation).
 
Inflation
 
               The behavior of commodity prices,
particularly in the period
subsequent to the Korean attack on June 25, has focused
attention on inflation as a major investment factor. As
currently used, the term "inflation" refers to any rise in
the general price level of a country. Basically, this is
caused by a demand for goods greater than the available
supply. High demand may be caused merely by enlarged
consumer disposable incomes but this source is usually
augmented by the expenditure of past savings and of money
raised through