A Distilled Markets and Macroeconomic Letter
October 2008

Detail Opinion
Blood in the streets
The S&P 500 is now (10/09/08) near the 2003 break out level. It is too soon to call a bottom and the fundamental picture remains grim at best. It’s interesting that the main stream media is not referring to this as a crash. If you look at a monthly chart going back 10 years, you will not find as much price movement as we have had this month and it’s only Oct. 9th. This market action, of course, comes directly after the passing of legislation for a $700 Billion bailout and global coordinated rate cuts. As I said last month, the crises are arriving more quickly and the “solutions” are having less and less of an effect on the markets.

Fed Heading Towards ZIRP?
Extrapolation Scenario Update: Hurtling toward the ZIRP Mountains($):
http://www.itulip.com/forums/showthread.php?p=53208
In my opinion, this is typical high quality material from iTulip

Lehman and Other CDS Settlements
Credit Default Swaps based on the failed firm Lehman will settle tomorrow. This is a must read:
http://bigpicture.typepad.com/comments/2008/10/lehman-cds-unwi.html
There will be other CDS settlements in October and the market sell off today (10/09/08) may have been, at least partially, associated with concern over the Lehman settlement. Here is information on CDSs:
http://bigpicture.typepad.com/comments/2008/02/cds-and-financi.html

More Things to watch:
A Bounce?
We could have a bounce at any time, but I would expect a bounce to fail and would not be surprised to see the markets head to new lows after a bounce.
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.

Unemployment
Here’s a chart that shows the broadest measurement of unemployment, via Paul Krugman’s blog:
http://krugman.blogs.nytimes.com/2008/10/03/the-track-record/

I expect unemployment to continue to rise.

Consumer Spending/Consumer Credit Problems
Consumer spending seems to be rapidly slowing and consumer credit problems are on the rise.

Forget Recession, Think Depression
While we might avoid a depression, how will governments/central banks fight this deflationary credit contraction? The only option that I can think of is to devalue the currency, which could send interest rates much higher among other nasty outcomes.

On the Bailout Package
I don’t think it will have much effect beyond putting more of a debt burden on the taxpayers. I also expect to see more requests for funds and would not be surprised to see the final numbers in the $1 Trillion to $2 Trillion range. Today AIG is back for $38 Billion more in addition to the $85 Billion credit line it acquired from the government: http://www.breakingviews.com/2008/10/06/aig.aspx

This deserves a reprint:
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
Stocks
Fundamental: Stock valuations are becoming reasonable but we may well continue to over shoot to the downside.

Technical: The S&P is currently at 909.92 and the 933.44 area may be resistance (10/09/08)

Bonds
I’m concerned that longer dated bonds (5 years to 30 years) may fall in value at some point, which may now happen sooner than later.

Gold
Gold has moved down to $906.50 (10/09/08)

Oil
Oil is at $86.59 (10/09/08). There is risk, in my opinion, that oil may stay relatively high indefinitely. I think $70 to $80 is relatively high. 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
In case you missed it, we are having a stock market crash. The Ted Spread has moved up to 4.23 from 1.21 last month. The VIX (volatility index or fear gauge) is at 63.92 (10/09/08).

Stocks - Medium Term - Elevated Risk
I believe the fundamental picture is still quite bleak. The credit/insolvency crisis seems to still be, at least, in a state of high crisis if not getting worse. Stocks are not a buy until support is found.

Bonds
I’m still concerned about longer dated (5 year and longer) bonds loosing value. This concept relates to the potential for a strong devaluation of the US Dollar.

Gold
Gold one month futures are at $906.50 (10/09/08). I’m watching Gold relative to stocks, Fed cuts, the Dollar, and other currencies.

Oil - Staying High
Oil is at $86.59 (10/09/08). 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 81.25 (10/09/08) (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 1.5% after an emergency cut.


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

ehodges@sfg-financial.com

925 906 4600

500 Ygnacio Valley Road
Suite 150
Walnut Creek CA 94596



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