The following commentary was recently sent to subscribers of the Forbes Special Situation Survey.

Although the Federal government now owns large chunks of formerly blue-chip companies, it seems investors have overcome their fear that capitalism is about to end. In fact, they now seem to believe that the worst of our financial and economic crisis is over. As a result, they are once again willing to put money at risk as evidenced by a number of factors. Spreads between yields on corporate bonds and Treasury securities have shrunk, the CBOE Volatility Index has declined significantly, and stock prices are up 40% from their March 9 lows. Yet despite this increased appetite for risk, we remain concerned that stocks will see another pullback. While there is plenty of evidence that the economy is deteriorating at a slower rate, we see nothing to suggest it is getting better.

First quarter earnings provided one catalyst for the stock market’s rally. Earnings were down from a year ago, but for the most part, they were better than expected. Many of the positive surprises were due to lower raw material and energy costs as well as layoffs and other aggressive cost cutting activities. More recently, however, commodity prices have been on an upswing. The Goldman Sachs Commodity Index, a composite of energy, metals, and agricultural goods, is up 41% from its recent low. The Energy Information Administration, which in January had forecasted an average price of $43.25 for a barrel of crude oil for 2009, recently upped its forecast to $58.70. With oil currently selling for more than $70 per barrel, it may have to revise its forecast again. This rapid rise in commodity prices will squeeze gross profit margins for many companies.

Furthermore, corporate layoffs have pushed the unemployment rate to 9.4%, its highest level since 1983. Yet those fortunate to remain employed are getting squeezed. A recent survey conducted by Challenger, Gray & Christmas indicates that 52% of companies have cut or frozen salaries. Many have eliminated benefits such as contributions to 401(k) plans. On top of this, the national average price of gasoline is up almost 60% since the start of the year. Less income and higher gasoline prices will reduce consumer spending, the most important component of GDP.

In addition, housing, where all the problems began, remains troubled. Sales may be stabilizing, but prices are still plunging. The government tried to help by forcing mortgage rates to below 5%. However, the long-end of the Treasury yield curve has suddenly jumped and so have mortgage rates. Higher mortgage rates will only prolong the housing crisis.

In short, the economy is still deteriorating. Yes, things may be getting worse at a slower rate, but they are still getting worse. We agree that a rally off the March 9 lows was fully justified. We also agree that even at current prices stocks are attractive from a long-term perspective. However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable. We are not suggesting you sell and get out of the market. Instead, take advantage of a pullback if it occurs to put more money into your favorite stocks.