Quarterly Commentary:
October 2007

This quarter’s report will be short.  I expect the fourth quarter to be rather quiet, at least from our tactical standpoint.  I also plan to cover many topics more substantially in the year-end review.

The Quarter in Review

Over the summer, the cracks in the real estate foundation widened suddenly in a sub-prime loan crisis, prompting a lending “spasm” throughout the credit markets.  Far from a crisis, this actually illustrates the beauty of creative destruction in our capital system.  Lending insanity finally caught up to a few large players, and the markets adjusted accordingly.

Most markets were only off 5-6% from all-time highs, and more pointedly, the subprime problem did not extend to all fixed-income securities.  Conventional mortgage rates stayed low.  Treasury yields actually fell.  A true economic crisis declares itself when all interest rate yields rise.

However, the Federal Reserve cut the discount rate by 50 basis points, signaling an apparent political intolerance for any financial pain.  I will discuss the ramifications in the year-end report, but for now I will foolishly make several predictions in writing.

 The dollar will fall, so much so that it may create a currency crisis.  While this may seem like an obscure concern, of interest only to economists and policy analysts, it means that imports (and we are predominantly an importing nation) will become much more expensive.  Oil will exceed $100/barrel.  Foreign investment, which has financed our ability borrow and consume, will demand substantially higher interest rates, outside the control of the Federal Reserve.  The stagflation of the 1970’s is coming back.

Tactics for the Fourth Quarter

I’m sitting tight.  While the fourth quarter may become volatile at times, I expect it to end well.  The enthusiasm over the discount rate cut, and the prospect of more cuts, will encourage investment, particularly among institutional investors who must look good by year-end.  We are sitting tight on our current positions.  Our portfolios are in an excellent position to profit from a falling dollar/inflationary scenario.  We have about 10-20% in cash, to cut volatility and for opportunistic purchases, but otherwise our energy is devoted to a 2008 game plan.