A Distilled Markets and Macroeconomic Letter
December 2008

Detail Opinion
Massive Bailouts/Liability
The total cost, so far, of the economic bailouts may be as high as $8.5 trillion, not including the $5.2 trillion for the Fannie and Freddie holdings: http://is.gd/aht8 (via Barry Ritholtz).

For perspective, these bailouts are larger, in inflation adjusted Dollars, than the combined total outlays for the: Race to the Moon, Marshall Plan, Louisiana Purchase, New Deal, Vietnam War, Iraq War, Korean War, S&L Crisis, and NASA’s all time budget (http://is.gd/ahwU).

These huge additional liabilities to the US debt may endanger the solvency of the country (http://is.gd/ahBI).

UN team warns of hard landing for Dollar
“The current strength of the dollar is temporary and the US currency risks a hard landing in 2009, according to a team of United Nations economists who foresaw a year ago that a US downturn would bring the global economy to a near standstill.” Via the Financial Times: http://is.gd/alj0

Stock Market Valuations/Expectations
“The S&P 500 Index’s current ten-year normalized PE of 14.9 and ten-year normalized dividend yield of 3.1%, investors should be aware of the fact that the market is by historical standards still only in ‘average value’ territory.” Via Prieur du Plessis: http://www.investmentpostcards.com/2008/12/03/us-stock-market-returns-–-what-is-in-store-2/

The markets have already undercut the 2002/2003 lows and lower lows are certainly possible. Several traders that I follow feel that we may eventually see the S&P at 450 to 600.

US Auto Industry
It seems that a pre-packaged bankruptcy is more likely than a direct bailout. This would allow the auto industry to reduce/eliminate pensions and labor costs, which may be the only way for the US car makers to survive.

Credit Crisis Continues
Various indicators are still showing that the credit crisis is continuing to plague the banking system. See the details at Calculated Risk: http://is.gd/aln8

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

“The U.S. credit card industry may pull back well over $2 trillion of lines over the next 18 months due to risk aversion and regulatory changes, leading to sharp declines in consumer spending, prominent banking analyst Meredith Whitney said.” Reuters via Calculated Risk: http://is.gd/aloD

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

Potential for Depression
More and more comparisons are being made to our situation today and that of 1929 and its aftermath. Despite this, many have the opinion that we will not have a depression. While a depression in our time may not look exactly like the 1930s, the risk of a depression is rising.

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The Markets
Fundamental: See above.

Technical: The S&P is currently at 845.6 and the 875 area may be resistance (12/04/08).

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

Gold has moved down to $760 (12/04/08).

Oil is at $43.56 (12/04/08). I feel that the collapse in oil prices is a “pricing in” of a global recession/depression.

Snapshot Markets
Stocks - Short Term - High Risk
Market indexes are flirting with breaking down further. The Ted Spread has moved back up to 2.18, which is still elevated. The VIX (volatility index or fear gauge) is at 63.64 (12/04/08), which is still very high.

Stocks - Medium Term - Elevated Risk
The fundamental economic outlook is still quite bleak. The credit/insolvency bubble continues to contract. Stocks are not a buy until support is found.

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 eventually.

Gold one month futures are at $760 (12/04/08). I’m watching Gold relative to stocks, Fed cuts, the Dollar, and other currencies.

Oil is at $43.56 (12/04/08). Oil has sold off sharply and seems to be pricing in a recession or depression.

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, if not further. The non-inflation adjusted (nominal) numbers may eventually not look as bad.

The Dollar (USD) is at 86.55 (12/04/08) (stockcharts.com ticker: $USD). Various risks to the USD seem to remain firmly in place. The USD is in a consolidation pattern currently.

Fed Funds are at 1% after an additional 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


925 906 4600

500 Ygnacio Valley Road
Suite 150
Walnut Creek CA 94596

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