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    Default TRANSPARENCY - December 2006 - Eric Hodges

    TRANSPARENCY

    A Distilled Markets and Macroeconomic Letter: December 2006

    by Eric Hodges

    Transparency Snapshot

    The Markets
    Stocks - Short Term - Negative Outlook
    A bit of a pull-back yesterday but the market is still in a positive mode. I believe that caution is strongly warranted. The VIX (the “fear gauge”) is at 11.62 (11/28/06), which is very low and can be a contrary indicator. There seems to be little fear in the markets. On a valuation basis, I believe that the market is very expensive. The housing downturn may weigh heavily on stocks.

    Stocks - Medium Term - Negative Outlook
    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?
    Yields have become more inverted. In the short run bonds may rise in price with a slowing economy but the longer-term bonds (5 year and longer) may eventually fall significantly.

    Gold
    Gold and gold stocks have been rising from early October. It will be interesting to see if gold will break above a key resistance level that it is near.

    Oil - Probably Stays High
    Oil has popped back up above $60. Middle East risk has been increasing recently, in case you missed it. More war(s) could raise the oil price even if we have a slowdown or recession. Oil could also fall significantly.

    The Economy
    Housing continues to slow and new car sales are still off. Consumers are loaded with debt. Christmas spending is not clear yet, but there is risk that it will not be that great.The Dollar has now slipped. Will this be significant? Yes, it may if the Dollar index falls below 80 ($USD). I feel that dollar based assets are at risk in the medium to long-term.

    Fed funds rate is at 5.25%. The Fed has continued to make comments that they are concerned about inflation. The risk is that the economy is slowing much faster than the major media pundits would have you believe.

    Transparency Detail

    A Deer in the Headlights?
    Bernanke was out and about today and Calculated Risk caught the TV coverage, which I missed. Their comment was that Bernanke looked like a deer in the headlights while he was trying to paint a nice picture of our economy. I made a comment a while back that Bernanke, when testifying to congress, looked quite nervous to me. I just don’t think it’s a good thing to have a Fed Chief that seems to be nervous about what is going on with the economy. I know, it’s completely subjective, but that’s how I feel.

    So what was Bernanke saying anyway? Housing may be worse than they thought. All of the iTulip.com readers are ahead of this game, though, right? You have all looked at the Shiller chart of housing, right?

    Just in case, here’s the chart via the New York Times:


    Purely Anecdotal Stories on Housing
    I have heard, via word-of-mouth, some very unsettling stories. Some home buyers here in the San Francisco Bay Area are still stretching to buy as much as they can in a home. I have heard stories of clients wanting certain information to be fabricated in order for a home to be purchased. Most interestingly, I have heard stories of mortgage brokers fabricating the income of clients without the client’s knowledge. And, apparently these things have been going on for some time during the boom. The story has been out for a while that clients were fabricating their income, but I had not heard of the brokers doing this without the client even knowing or asking. This is all, if true, symptomatic of a speculative bubble in my opinion. Gary Shilling’s recent piece on housing via John Mauldin is excellent and very doom and gloomish.

    Recession in 2007?
    Eric Janszen has written a great three part article on a potential recession in 2007. That’s on itulip.com for my email list readers. I also continue to read Nouriel Roubini’s, commentary on the same subject. Both iTulip and Roubini have done a great job of breaking down the statistics that you hear out of the mainstream media. Roubini is dead-set on a recession in ‘07 and Janszen leans strongly in that direction as well. I feel that there is substantial risk for a recession or worse, but the timing is hard to call.

    The Markets

    Stocks
    The Dow has come down a bit from record highs. The Transports are still not confirming, which is not good for those betting that stocks are in a new bull market. I suggest reading Richard Russell’s excellent articles on this topic. Earnings are at record highs by about 100%. If earnings were at the historic median level, the market would then be judged to be very expensive. Most commentators are ignoring this. Take a look at John Hussman’s work.

    Bonds
    The yield curve has become more inverted. Or, in other words, short duration bonds are higher in price when compared to longer duration bonds. This inversion along with other indicators point to a higher likelihood of a coming recession.

    Gold
    Gold has now been moving higher and may be close to breaching key technical levels on the upside.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 become weaker recently but has not gone down through the key technical level of 80 ($USD). Long-term I’m 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
    Oil is at $61 (11/28/06). The risk is that oil stays high. If oil prices move downward substantially, they may be pricing in a recession. Much has been written about how the world is currently experiencing peak oil production. If we have a recession, especially a global recession, we might not have to worry about peak oil for a while. When the economy recovers from such a recession, oil prices could go much higher.

    Will new sources of oil come firmly online in the interim?

    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. Richard Russell thinks that there is risk that the Fed will not cut even in the face of a recession in order to support the Dollar.

    Housing
    I feel that the housing picture could become much worse.Barron’s reported (8/21/06) some interesting statistics on housing: 10% of all home owners with mortgages have no equity in their homes and $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 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. Maybe next the consumer will be squeezed by their mortgage payments being reset.

    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.

    If you have specific questions, 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

    The information being provided is strictly as a courtesy. When you link to any of these web-sites provided herein, FSC Securities Corporation, makes no representation as to the completeness or accuracy of information provided at these sites. Nor is the company liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, sites, information and programs made available through this site.

    The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Investing involves risks including potential loss of principal.

    The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredictable international monetary and political policies.

    Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. In General the bond market is volatile, bond prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

    The price of commodities is subject to substantial price fluctuations in short periods of time and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to higher price volatility.

    The views expressed are not necessarily the opinion of FSC Securities Corporation, and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. With any investment vehicle, past performance is not a guarantee of future results.

    Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness of reliability cannot be guaranteed.

    Registered Representative offering securities and advisory services through FSC Securities Corporation, a registered broker-dealer member NASD, SIPC & A SEC registered investment advisor.
    Last edited by FRED; 12-11-06 at 03:12 AM.
    Ed.

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