A Distilled Markets and Macroeconomic Letter
November 2007

Transparency Snapshot
Stocks - Short Term - High Risk
The large commercial investors seem to still be positive on this market, so it might take more bad news to see further declines. The VIX (fear gauge) has been moving higher again. The fundamental picture is bleak in my opinion. The credit/insolvency crisis is getting worse. The very short term technical picture is negative in my opinion.

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.

Bond yields are lower. Iím still concerned about longer dated bonds loosing value.

Gold one month futures are at $810 (11/05/07). Gold has had a big move up.

Oil - Staying High
Oil is at $93.98 (11/05/07). If we have a slowdown or recession, oil might have a steep sell-off. I think there is significant risk that with Fed rate cuts we could continue to see high/relatively high oil prices even with a slowdown/recession.

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 seem to be loaded with debt.

The USD is at 76.43 (11/05/07) (stockcharts.com ticker: $USD). I feel that dollar based assets may be at risk in general, both near and longer term.

Fed Funds are at 4.50%. I think the Fed will continue to cut rates if more bad news in the financial sector comes to light. I, of course, expect to see plenty of bad news.

Transparency Detail
Housing/Credit Crisis
Although many large banks are now realizing losses, I think there is much more to come. From what I have read, the amount of losses publicized so far may be far below the totals invested in the structured products that are based on mortgages. The banks seem to be trying to recognize the least amount of losses possible. I think they are trying to buy time while hoping that the situation improves. In my mind, there is no reason for the situation to improve.

I feel this way for several reasons:

1. There are many more mortgages that could reset and I feel that these will reset to higher rates over the next few years, perhaps through 2011 or further.

2. If these mortgages reset this may add more housing inventory and may reduce consumer spending.

3. I feel that the home builders who have housing developments either unsold or nearing completion may cut their prices until these homes sell. This may add to the already high housing inventory.

4. If the crisis worsens, I feel that the Fed will continue to cut the Fed Funds Rate despite the current talk that the Fed is on hold for now. This may cause the Dollar to continue to fall and also may cause oil and other items to increase in price.

5. As I have said before, I donít think additional Fed cuts of short term interest rates will help investors (banks and other institutions) who are holding investments that may be worth much less than when they were bought. Additionally, many of these investments may have been made with borrowed money. Losses may then roll over to the lenders of this money thereby widening the crisis.

I feel that this crisis is inherently deflationary and that the Fed will fight it by cutting rates. I donít think that this will be a cure. I feel that the Fed has decided to sacrifice the Dollar in order to try to protect the economy. Also note that at some point this strategy may cause bond yields to rise and bond prices to fall.

The Markets
Fundamentals: In short, I feel that the market is overvalued on a historical basis. If we see higher inflation, the market may move higher in Dollar terms but could well remain challenged in terms of other currencies.

Technical: On a very short term basis the market looks weak and I feel that the ďinternalsĒ of the market are not good.

Iím concerned that longer dated bonds (5 years to 30 years) may fall in value at some point.

Gold has broken out above the recent high prices. It will be interesting to see if it can maintain this rally.

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
Iím looking to see if the Dollar can rally and if so how far. Long-term Iím still negative on the Dollar. The real story is the Dollar against gold and oil etc., where the Dollar has lost a huge amount of value and may lose much more.

Oil is at $93.98 (11/05/07). There is risk 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
See above.

See above.

~ $1 Trillion in mortgages may reset in 2007.

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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