A Distilled Markets and Macroeconomic Letter
September 2008

Detail Opinion
A main concern of mine, that all investment classes could fall at roughly the same time, seems to be taking place. We will see how long this situation lasts. Things to watch: Dollar/Gold, Dollar/Oil, further financial implosion, Fed cuts/special lending facilities, and further Treasury socialization of risk, etc. Key point: with each passing government intervention, the market has exhibited less strength (http://bigpicture.typepad.com/comments/2008/09/each-crisis-has.html). Each crisis has been followed by a larger crisis.

Fannie Mae/Freddie Mac
This rescue/bailout/socialized risk/etc. “solution” may result in a minimum cost to US taxpayers of around $250 billion by one estimate. One would think that this would be a negative for the Dollar, but it is on a counterintuitive tear currently. I just to a look at both local and national main-stream media and didn’t see any current articles on what this bailout will cost taxpayers. There is, though, a lot of chatter on the better financial sites/blogs.

Lehman and Washington Mutual
The New York Times is reporting that Lehman is looking for a buyer and the stock closed down 41.8% today (09/11/08).

Washington Mutual was down around 25% today but recovered to finish up 22%. This move does not look convincing on the charts yet. I would not be surprised to see Washington Mutual fail.

With home prices falling drastically, the financial sector may continue to be under severe pressure. At some point this may cause the Fed to cut rates again despite the inflation in some consumer prices and still high gas prices. Further Fed cuts may help to keep oil prices relatively high. The NY Times is reporting that the current inflation problems are “all but assuring” that the Fed will hold steady on rates. If the financial sector continues to have problems, this may not be the case.

Speaking of financials, there is an interesting article on iTulip on the burst of the credit bubble: Debtwatch No. 25: How much worse can “It” get? (http://www.itulip.com/forums/showthr...2596#post42596). Eric Janszen’s recent commentaries are also very worth while.

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The Markets
Fundamental: In short, I feel that the market is overvalued on a historical basis, though it is less overvalued than in October 2007.

Technical: The S&P is currently at 1249.05 and the 1250 area may be resistance.

I’m concerned that longer dated bonds (5 years to 30 years) may fall in value at some point, although this may be a bit further in the future. This concern seems to be rising, though, with further USD weakness.

Gold has moved down to $748.90.

Oil is at 101.02 (09/11/08). There is risk, in my opinion, that oil may stay relatively high indefinitely. Current oil prices may be reflecting a global recession. Concerns that oil supply could be reduced by war seem to have receded. There are many other potential geopolitical risks to oil as well.

Snapshot Markets
Stocks - Short Term - High Risk
The market has broken recent support to the downside. The Ted Spread has moved up to 1.21. The VIX (volatility index or fear gauge) is at 24.39 (09/11/08).

Stocks - Medium Term - Elevated Risk
I believe that there is significant risk that the market averages may have quite low returns for some time or potentially flat/negative returns when inflation is taken into account. The fundamental picture seems quite bleak. The credit/insolvency crisis seems to be getting worse.

I’m still concerned about longer dated (5 year and longer) bonds loosing value.

Gold one month futures are at $748.90 (09/11/08). I’m watching Gold relative to stocks, Fed cuts, the Dollar, and other currencies.

Oil - Staying High
Oil is at $101.02 (09/11/08). Oil has sold off sharply and seems to be pricing in a recessionary, or worse, economy.

Snapshot Economy
The housing/credit/insolvency crisis is still in force. Home prices have fallen in many areas, some quite significantly. I feel that we could see home values have a total drop from the peak of 20 to 30% nationally in 2008 Dollars. The non-inflation adjusted (nominal) numbers may not look as bad.

The Dollar (USD) is at 80.22 (09/11/08) (stockcharts.com ticker: $USD). The USD has made a potentially significant move up. Various risks to the USD seem to remain firmly in place, however. A key level to watch may be 82.

Fed Funds are at 2%.

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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