A Distilled Markets and Macroeconomic Letter
June 2007

Transparency Snapshot

The Markets
Stocks - Short Term - High Risk

The large commercial investors are still buying this market, which may continue to push prices higher. This could change at any time. Margin debt is at record levels, the VIX is very low, and the economy is slowing.

Stocks - Medium Term - Elevated Risk
I believe that the risk is the market averages may have quite low returns for some time or potentially flat/negative returns when inflation is taken into account.

Bonds - Inverted yields pointing towards recession?
The yield curve is less inverted. Yields are pushing higher in the longer duration bonds. This should put additional pressure on housing if these rates stay at higher levels. Short term yields are down today (5/31/07).

Gold is has moved up a bit with GLD at 65.5 (5/31/07).

Oil - Probably Stays High Unless...
Oil is at $62.86 before the close (5/31/07). Factors for increased price near-term: terrorism, war, or other supply disruptions. Factors for a reduced price near-term: an economic slowdown, less terrorism, Middle East Peace.

The Economy
The housing crisis continues to worsen and there are plenty of Adjustable Rate Mortgages that could still reset to higher payments. New car sales are still off. Consumers are loaded with debt. GDP for the first quarter of 2007 is .6%, which is quite slow.

The USD is at 82.44 (5/30/07) (stockcharts.com ticker: $USD). The Dollar may has had a bit of a rally. I feel that dollar based assets may be at risk in general, both near and longer term.

Fed Funds still at 5.25%. The Fed may not want to cut rates immediately in the face of an economic slowdown, which would probably be unpleasant for the markets.

Transparency Detail

Housing continues to be weak. An interesting site to look at on this subject is Calculated Risk. The site gives insight into the smaller details while iTulip.com has the big picture (or Macro) information. iTulip has also reported some very interesting information on investments that have been sold that are based on mortgages.

The conventional wisdom is that the subprime mortgage problems are ďcontainedĒ within that specific market. The opposing view is that the problem also exists in higher grade mortgage markets. An additional point is that the home builders have been making very negative statements about their industry and these builders have a lot of inventory left to sell. This could put significant downward pressure on prices in many markets.

The Markets

Technicals: The US markets are currently slowing (5/31/07, before the close). The markets have moved up significantly and are still in a positive, bullish, mode. This may continue for some time. The risk is that the markets may have a large sell off that could erase months or years of gains.

Fundamentals: You might want to read John Hussmanís commentary on market valuations. In short, the market is overvalued on an historical basis and most people just donít believe this to be the case. I agree with Hussman.

The yield curve is still inverted, but less so. Short yields are down today and the longer yields are up. If these levels hold or move higher, it should put more upward pressure on mortgage rates.

Gold is holding up fairly well for now. If gold now moves lower, I will be concerned that it is pricing in a recession. Gold might move higher if the Fed decides they need to cut rates.

Reminder: fiat currencies are not tied to anything of tangible value. They are only worth whatever the market, and the public, feels they are worth. As more fiat money is created the value of this paper money should go down. In my opinion, the U.S. is creating too much money and so are China, Japan, and Europe.

Dollar | Currencies

The Dollar has rallied back to 82.5. Long-term Iím still negative on the Dollar. The real story is the Dollar against gold, where the Dollar has lost a huge amount of value and may lose much more.

Oil is at $62.86 (5/31/07). The risk is that oil stays high. If oil prices move downward substantially, they may be pricing in a recession. A major concern with oil is the potential for a wider conflict in the Middle East, which could crimp supply. There are many other potential geopolitical risks to oil as well.

The Economy
The Fed

The Fed is in pause mode and it seems that they will stay in pause mode for a while. If housing and the economy slow enough the Fed should start cutting rates again. There is risk that the Fed will not cut even in the face of a recession in order to support the Dollar.

I feel that the housing picture could become much worse and now, at least in the Subprime market, it seems to be happening.

~ $1 Trillion in mortgages may reset in 2007.

The key chart to reference on housing via the New York Times.

The Consumer

The Consumer

I believe that many consumers have less home equity now than before because they have taken money out of their homes and spent those funds. Consumer savings rates are very low or negative. I believe that consumers are being gradually squeezed by high oil prices on one side and rising interest rates on another.

Transparency Strategy
My concept is to bring you a the most transparent look possible on the economy/markets via a quick read with plain language. This letter is geared toward the busy executive/business owner. If you are really short on time just look at the Snapshot section where I keep everything as brief as possible. In the Detail section I try to give a little more insight into my thinking without delving so deep that I stifle the reader.

When constructing portfolios, I take the client situation into consideration first and then combine that with the current economic/market factors presented in this letter along with well researched asset allocation strategies.

If you have specific questions on where I see things, or would like to discuss your portfolio, please feel free to contact me.

Eric Hodges
Financial Advisor
Stahlschmidt Financial Group


925 906 4600

500 Ygnacio Valley Road
Suite 150
Walnut Creek CA 94596

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interest rates on another.