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    Jun 2006
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    Default TRANSPARENCY - January 2007 - Eric Hodges

    A Distilled Markets and Macroeconomic Letter: January 2007

    Transparency Snapshot

    The Markets

    Stocks - Short Term - Negative Outlook but Positive Mode
    The market is still in a positive mode. I believe that caution is strongly warranted. The VIX (the “fear gauge”) is at 10.95 (12/28/06), 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 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 are up a bit but the yield curve is still 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 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 with an economic slowdown.

    The Economy
    Housing continues to slow and new car sales are still off. Consumers are loaded with debt. Christmas spending by consumers was flat on an inflation adjusted basis. Is the consumer starting to significantly slow their spending?

    The Dollar has pulled back a bit and has stayed above the key index level of 80 ( ticker: $USD). I feel that dollar based assets may be 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

    Priced to Perfection
    Once again, it seems that the market is priced to perfection. Markets can run in one direction a lot longer than many expect and the current market has done just that. So how long will it last? That’s hard to say, but as the market continues to move higher the risk to the downside only increases. Has the risk of international and domestic terrorism gone away? Is there now less risk of a wider Middle East conflict? Is housing now rebounding as recent news stories would lead many to believe? Could the current wave credit/debt for mergers and acquisitions be a bubble? Have you tried to take these risks into account in your portfolio?

    Some Articles that Show Potential Risks
    Eric Janszen has just released his Recession 2007 Part IV: The Year Ahead, which examines several large risks to the markets and the economy.

    Mark Hulbert wrote an article in the New York Times that correlates high merger activity with market tops($).

    The Big Picture reports that goods moved via trucks, measured in tons, is down significantly.

    Nouriel Roubini’s blog takes an interesting look at current data points for housing and manufacturing (Dec. 27th and 28th blog entries).

    The Goal
    This via John Mauldin: “Gary North has a good definition of being rich. You are rich when you have enough assets to live off the income (return) from the principal in the style you want to be accustomed to, taking into account inflation.”

    The Method
    Earn near-market, market, or better than market returns over your investment time horizon with less volatility and while avoiding large losses. Hopefully this will not be harder over the next 30 years than it was over the last.

    Best wishes for a good 2007!

    The Markets

    The Dow is near 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.

    The yield curve is still 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 has now been moving higher and may be close to breaching key technical levels on the upside. If gold now moves lower, I will be concerned that it is pricing in a recession.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 had a mild bounce up. 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 is at $60.40 (12/28/06). 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.

    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.

    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

    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; 01-08-07 at 04:27 PM.



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