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To All My Investor Friends: Happy New Year 2007

2006 for me was a year of change (maybe that is true for all years!) It is
the year that my son left home and into his own condo. It is a year that saw
the passing of my wife Susan’s mother, Renae. My daughter turned 16 and is
now driving her own car. Such changes give me perspective on life in general
and make me more appreciative for the gifts I have been given for the
relatively short time I am here.

This is my sixth year writing an annual financial newsletter cum forecast.


It is my pleasure each December to work on this and share my ideas with you.
Whether or not you use any of the information and profit from it.

Here is what I said in last year’s newsletter in January 2006 (all my


previous newsletters are posted on my Wealth-Ed.com website for your review):

To summarize the theme for 2006: “it is all about Bernanke”. The big change
this year will be what the new Fed Chairman decides to do with the Federal
Funds overnight rate.

I think this two-sentence analysis for the coming year, made two months
before Bernanke took over Chairmanship, was very accurate. 2006 HAS been all
about Bernanke. But what has surprised most investors and me is how
successful Bernanke has been in managing the GNP and housing growth slowdown
without incurring either run-away inflation or a recession. I had factored
in a high likelihood that he would not pull this off and had become very
defensive by May. I expected the Fed to overshoot on the side of tightening,
precipitating a significant recession (which would have made my forecast of a
stock market low of DOW 8500 a reality). This is what previous Feds have
done in similar circumstances, where growth, speculation (real estate in this
case) and energy costs are above upper acceptable limits. Given my
underestimation of Bernanke’s Fed, I still did all right on my market
forecast:

Based on the above historical and current events analysis here is my game
plan for 2006: A range of 8500 to 11,500 for the DOW (just about the same as
2005 and the third year in a row for this forecast range), 900 to 1500 for
the S&P500, 1800 to 2500 for the NASDAQ Composite. I think that the weakness
this year will come in the first half of the year with a bottom during the
summer coinciding with acknowledgement of the mild recession brought on by
short term rates between 5% and 6%. After that, the pre-election fiscal
stimulus, and the end of interest rate increases coming into sight, will
cause a market rally during the fall and early winter, culminating in a
significant “Santa Claus” rally which went missing this past year (2005).

Other than being too conservative on the upper range for the DOW Industrials,
I would have to say this overview / prognostication was spot on, with highest
prices at the end of the year (as of today, Dec. 27, DJI = 12,410, SP500 =
1415 and NDQ COMP = 2414). But I will admit to you that I didn’t believe my
own words with enough conviction to get back into the market in a big way at
the “summer lows” in July. As often happens, in the heat of the moment, it
seemed that the problems in the economy (namely a weakening economy with
inverted yield curve, Israel-Hezbollah trouble and high energy prices) were
conspiring to delay the recovery. Also, we did not really get a “mild
recession” but only a slowdown in GNP growth, which continues today in the 4th
quarter of 2006 and into 2007. So, I did not benefit like I could have had I
just reread my letter and acted on its words of advice. I may have given up
10% of return for the year on my portfolio, but was very safe in doing so.
Peace of mind can be worth lost opportunity (at least that is what I am
telling myself).

Last January, I was also very convinced of a real estate (housing)


correction. Speculating on real estate had become a national past time.
Pricing in many locations, especially on the East and West coasts, had lost
touch with reality. If rising interest rates didn’t do the trick (at the
time, there was speculation that Bernanke would raise Fed Fund rates to 6%),
then low affordability would. There are logical limits on the percent of
income that a family can pay for mortgage payments and that would eventually
stop the housing price increases. I cited a new book by Dr. Robert Shiller
that provides academic research behind the theory of real estate pricing:

Dr. Robert Shiller (Yale University) precisely defined very long run real
estate growth at 1% over inflation in his new book, “Irrational Exuberance
2”…. This number was arrived at by extensive historical research conducted
by a squad of graduate students…. Second, I believe government and industry
data from the last couple months (nearly 20 year high in housing inventory on
the market, “days on market” at over 60 days, another 20 year high), shows
that the real estate bubble is in the process of being popped. This is due
in large part to the commitment of the Fed to raise interest rates and
discourage excess lending. We will know more next year at this time how
severely the real estate markets turn down, which geographic markets are most
affected and whether all of this precipitates a recession.

This observation / prediction has also proved accurate, though again, the
Bernanke Fed has done a better job containing the real estate market trouble
than I would have guessed based on historic examples. While the very short
term Fed Funds rate has been maintained at 5.25%, there has been no
accompanying liquidity squeeze / credit crunch like in 1990-91 or the early
1930s. This has made it relatively easy to obtain a mortgage for refinancing
adjustable or Option ARMs. And because of the re-circulation of US Dollars
earned by the Chinese and other net-export countries back into our economy,
the 10 and 30 year T-Bond interest rates most important to the mortgage
market, have been held relatively low. All this suggests that in the absence
of some large but unpredictable global financial “accident”, the Fed and
other central banks will be successful in managing economic growth and
credit. But if there is an “accident” where will it originate?

The unwinding of the housing bubble has yet to run its course. Only now the
sub-prime ARM and Option ARM mortgages are adjusting that financed real
estate speculation and marginal borrowers the past 3-4 years. Most sub-prime
borrowers were forced to exotic mortgages by the high price of real estate
and their inability to qualify for standard fixed rate mortgages (which goes
to the point of housing affordability as a lid on the market). Some say that
people with ARMs can always refinance to a fixed rate product at market rate
(now about 6.25% for 30 years) if there is a need. But the flaw in the logic
is that it took a low 2% interest rate ARM to qualify those borrowers
originally. Now, they must requalify at the higher rate, and most likely
with a lower assessed value on their property. Those borrowers who cannot
meet the higher standards will be forced to default on their mortgages.

Because housing real estate is so illiquid (hard to sell), and because most
people will do anything to avoid foreclosure on their home and loss of all
their principal, mortgage defaults are a slow moving train. It will take up
to two more years to see what damage the housing bubble will cause. If the
economy holds up, the damage may be light. However, if there is a recession,
even mild resulting in job losses, the damage to the real estate market and
the economy will be much worse.

It is the slow motion bursting housing bubble that might precipitate a much
deeper economic crisis than most are forecasting. Watching for an increase
in foreclosures will signal the crisis too late. Instead, watch the monthly
economic data on joblessness / unemployment rate and consumer confidence. If
those become negative the next 3-4 months, then we will have a much worse
correction.

To avoid the pain of such a steep correction, my allocation today is to hold


50% cash and other short term funds, 15% equities, mostly large cap without
any housing exposure (exclude large banks that today seem cheap and have high
dividends, like Washington Mutual or Wells Fargo), 15% North American based
oil and gas trusts and 20% international equities, where economic problems
will likely be less severe than the USA.

Eight things to consider in 2007 for financial security (2006 suggestions in


Italics for comparison):

I believe this upward trend in commodities and gold will continue for some
time. It has only just started. The gold cycle is similar to the oil cycle.
Both benefit from both being valued as “hard assets” with intrinsic historic
value, even though the values are different to homo sapiens. As our trade
and budget deficits continue to weaken the dollar, it becomes less attractive
as the world’s “reserve currency” and gold becomes more attractive. This
change in thinking will take years to play out as gold continues its march to
$2000 per ounce.

1. After a great start to the year, gold and precious metals flattened out
during the second half, along with other commodities. I continue to hold
gold in a mutual fund, the Vanguard Precious Metals and Gold fund (VPGMX). I
have also bought mining companies from time to time, or speculated in their
options, such as Yamana (AUY) or Anglogold (AU). Long term, gold continues
to look good for all the reasons given in previous years. This is a long
term story, and while gold may not head straight up, it will continue to
appreciate in the face of a weakening US currency.

Stay conservative (Still True and will be until equities are again
cheap…below 10x current earnings); I still think this is not a time for the
market to rally. The market price to earnings ratio is not anywhere near a
typical low in respect to valuation, at the current 17 or 18 times (even
higher once employee stock option expenses are deducted from earnings, which
will be required by July 1, 2006). But a 10x earnings factor would require a
significant inflationary environment. I am not as convinced of runaway
inflation as last year, especially with Ben Bernanke as Fed Chairman. So I
am changing the definition of a “cheap stock market” to 13 times in a 5%
inflation environment.

2. The stock market action in the past 4-5 months has suggested that an
extended rally may be around the corner. Still, the market has come a long
way off the summer bottom and it needs to take a little time off. Also, the
economy continues to cool and the market will not advance until economic
growth changes direction (or more accurately, until the market anticipates
the change). USA GNP growth is currently at around 2% and still declining
(from 5.6% in Q1 2006). Assuming the Fed can avoid it dropping below 1%, it
should turn around by the Q3 (July) of 2007. Between now and then, it may be
a tough environment. But once it does turn, and assuming profits stay
relatively strong as they have since 2003, then we are set up for a very good
stock market run. The market P/E is now at close to its historic average of
15. If market price corrects in the first half of 2007 by 15% to 1200 on the
S&P 500 index, for example, with no decline in profits then market P/E will
be below 13.5. In this low interest environment, as stated last year, that
may be as low as it goes and will represent a great buying opportunity.

I predicted oil would move from $25 to $50 in 2005 and it did. This is why I
think that 5% inflation is baked into the cake, even though government stats
don’t yet report it. Commodities of all kinds have increased 2-5 times over
what they were in 2000 (when oil was $10 for a time). Much of this is offset
by imports of cheaper manufactured goods from Asia. But going forward,
imports will not get any cheaper (higher commodity input prices and
increasingly higher labor costs are also a reality in China) and the higher
costs of commodities will work their way through the world economy.

3. Higher commodity prices in a growing world economy are a fact of life.


Though commodities are taking a break the past 6 months, with oil, silver and
gold all flat and copper actually falling, I think this is a temporary
respite. There is no reason to believe that global resource supplies have
been dramatically increased, but demand continues growing keeping pace with
growth in world economies, especially the very large BRIC economies (Brazil,
Russia, India and China). These are enormous countries with commensurate
appetites for natural resources. That will not change for the rest of my
lifetime. I continue to be overweight oil and precious metals. Now is a
good time to increase positions as commodities have temporarily lost favor
with investors and are relatively cheap.

I have provided detailed explanations in past issues as to why oil can go to


$200 per barrel by 2010 and why gold can go to $2000 per ounce by 2015.
Limited supply and increasing global demand affect both. Gold is an
especially interesting situation given the need for China to diversify its
foreign reserves away from US dollars, so that it can de-link its currency.
Both oil and gold must go higher in US dollar terms if the dollar continues
to weaken against other currencies. Until we in the USA change the direction
of the national debt, commodities will be an attractive investment.

Sell REITs and any commercial real estate holdings; we are at the peak of a
20+ year real estate cycle; REITs will be hurt by higher interest rates and
an eventual economic downturn in 2006. I haven’t changed my views on real
estate since I said “Cash out now;” in 2004” and won’t change until we get
those REIT dividend yields back to 7-8% like they were in 1995 through 2000.
What is required is for real estate to decline relative to other asset
classes and rents / revenues to increase. REIT yields are now less than
super-safe 6 month T-Bills.

4. Darn, wrong again! REITs continue to confound my expectations. The “fly


in the ointment” with this advice has been the avoidance of a recession.
While residential real estate is undergoing a predicted correction from its
lofty levels, as long as commercial real estate has high lease rates and the
ability to increase rents in a tight market, REIT prices will stay strong.
Still, with average dividend payouts remaining at less than 5%, much lower
than historical averages, the longer-term outlook for commercial REITs is not
good. Remember, that REITs must pay out 95% of their profits to shareholders
(limited partners). A 4.5% REIT payout is not the same as a 4.5% dividend at
a bank like Wells Fargo or an integrated oil company. Those companies may
pay out less than 50% of profits and still have a lot left over to reinvest
in growing the business. The only way a REIT “grows” its capital base is by
issuing more shares, diluting current shareholders. Otherwise, the
appreciation must come from the value of the underlying real estate, which
may or may not continue in the future. Even if those values don’t decline
they should only grow with inflation adjusted GNP over the long term (1%
annual). REITs will need to drop by 30-40% to go back to a historical 7-8%
dividend payout. A lot of money will be lost in REITs at some point.

Classic recession proof / defensive sectors like consumer staples and defense
did not do well because the economy held up well against all odds. But
defensive energy and healthcare proved to be very good sectors for 2005,
placing first and third out of the ten S&P sectors (utilities, another
defensive sector was No. 2). I wouldn’t make any changes to this prediction,
since I think we will finally see the economy weaken in 2006, though I have
lowered my energy exposure since it has become fully valued at this time.
Utilities, which I never bought, are also fully valued.

5. The market finally began moving towards large caps the past 3-4 months of
2006. This is typical of a late stage market that sees a narrowing of
participation and eventual divergence between market sectors. The move to
large cap is also consistent with a more defensive posture by investors as
economic growth diminishes, which it has. While large cap industrials have
been moving up, the DOW Transportation index has been moving down, which is a
long known technical warning sign for the stock market (based in original DOW
theory). This last happened in 1999, and we know what happened next. If we
are in the last stages of this cycle and a significant correction is around
the corner in the first half of 2007, then large cap “Value” stocks are a
good place to be. It is also a good time to reduce stock market exposure and
move towards cash or short term bond instruments.

Gold mining stocks increased over 40% in 2005 after years of doing nothing.
All the commodities did well in 2005, especially the first half. We are in a
bit of a pullback in most commodities as they have become over-owned and the
target of speculation, but I think this is a significant long term trend and
will add to my positions on price weakness.

6. The commodities and precious metals theme turned out to be my best call
for 2006, especially early in the year. Gold went from $530 an ounce on
January 3 to $725 on May 12. From that point, it has moved down and then
sideways the past six months. Gold and precious metals mining funds were the
best domestic sector in the stock market for all of 2006. As stated a couple
pages ago, this upward cycle in gold prices is a long-term process that has
major global economic themes underpinning the move. It continues to be a
good investment for 2007, even if short-term economic weakness results in
flat or slightly lower prices through mid-summer. Once the economy regains
its footing, gold prices will move up with economic growth.

Hi-yield or junk bonds are at cyclical high prices and will only go down,
especially with increasing defaults at the next economic downturn; wait for
the next recession to rebuild junk bond positions; This was the proper
recommendation for 2005, though the long bonds did not get hammered as
expected. So anyone who did not shorten duration or improve quality got a
break. Given the economic environment and the flatness of the yield curve as
of this date (January 2, 2006), in 12 months, either long bonds will be at 5%
and maybe much more, or we will be in a recession, at which point, short term
rates will be on their way down. Neither scenario is good for high risk
bonds. Stay short.

The yield curve has remained remarkably consistent and flat for all of 2006.
The Fed concluded its rate increases in July at 5.25%. Shortly after that
the prospect of economic weakness in the second half of 2006 into 2007 caused
long term rates (10 and 30 year) to move down towards 4.5%. This resulted in
an “inverted yield curve” that presages economic declines or recessions.
While we have avoided a recession so far, a decline in the economic growth
rate has come to pass. Normally during an economic decline, some poor
quality bonds (junk bonds) go into default and are written off. This process
causes junk bond funds to reverse direction and decline in price / increase
in yield to compensate the higher risk.

That has not happened. But there are some antecdotal signs that the process
is just starting. Several small “sub-prime” mortgage lenders have recently
been downgraded or have been closed. To the extent they default on any
borrowings of their own, this should start to drive junk bond prices down.
If the lending problems spread to the general economy, then more and larger
borrowers will be affected. This would help move the spread between super
safe Treasuries and junk bonds back to its historical average of 4-6%.

Junk bonds should be avoided, but “secured” senior obligation debt funds,
like Nuveen’s “JRO” might be considered. Secured asset funds have a senior
position to even bonds. So, default is unlikely, even if the funded company
declares bankruptcy. Another good option as longer-term interest rates go
back to their normal relationship to short term rates will be Treaury
Inflation-Protected bonds (TIPS). These have been poor investments the past
two years as the real return has been under 2%. But during times of economic
growth and increasing long term interest rates, it is not unusual for real
returns to approach 4% (as was the case in 2003). With inflation at 2%, any
TIPS return over 5%, for a 3% plus real return, should be locked in.

A simple way to protect against a declining dollar is the purchase of


unhedged international funds; this is another good strategy that has paid off
big time for me. I have particularly liked Asian stock markets that are
benefited by the Chinese economic juggernaut. The (weakening) dollar
situation did not work (in 2005), as earlier noted, so there was not a boost
from exchange rate changes. But even with a strengthening dollar, the Asian
markets had a very good year. My ETFs in Korea (EWY, 53.89%) and Japan (EWJ,
24.34%) were especially rewarding. This is a good time to sell half of my
Asian stocks to take profits and protect against a sell-off, but keep half
for continued exposure to the world’s best growth market for the next 20
years. And I still believe the dollar will eventually devalue against other
currencies, so that stock price boost is yet to come.

8. Other than gold and commodities, international stocks have been the big
story in the markets for 2006. I have been pounding the table for an
overweight in international for as many years as I have written this
newsletter. For that entire six year period, international markets were
underpriced compared to the US markets. Now, that may have changed.
International markets, especially Asia-ex Japan, were big winners in 2006.
China was up 100%, Hong Kong 40%, South Korea 30% and so on, as compared with
15% for the broad USA market.
The China and Asia growth story will continue for many years. Those growing
and exporting economies will greatly affect our future. Interest rates,
inflation, and employment will all be subject to the Asian growth story. It
will be a great challenge for the Fed to steer us through the obstacle course
presented. In the next 3-4 years, the dollar will continue to weaken as
Asian central banks gradually de-link their currencies from the dollar and
let those currencies float. As the Asian economies buy less US Treasury
products to exchange for their dollar reserves, it will put upward pressure
on interest rates (more supply to finance our national debt but less demand
from foreign borrowers). A weakening dollar is implicitly inflationary. A
weak dollar requires a higher price to buy imported goods (including oil and
gold). Those price increases on all imported goods result in inflation.
Higher goods prices put pressure on labor markets to demand higher wages.
The deflationary pressure from cheap imported goods from Asis that kept a lid
on inflation the past 10 years is over.

As the dollar weakens and devalues the paper holdings of Asian central banks
and businesses those entities will trade their dollars for hard assets, such
as American businesses and real property. We have seen this all before in
the late 1980s when Japan went on a buying spree in America, for the same
reason. But our debt to China and Asia is many times the size on a per
capita basis as it was for Japan. We will be required to sell a large
percentage of America to pay our bills. But in the long run a free market is
always what makes our country stronger.

After several years of out-performance, the international markets no longer


deserve an overweight, but should be reduced back to a more typical 10-20% of
a portfolio. The USA is now one of the cheapest markets in the world and
should have an overweight in equities, at least after we have passed through
the expected correction. The only major market that is now cheaper than
America is Japan. So, an overweight in Japanese stocks or indexes is called
for.

Still, Asia is where the growth in the world will be the next 20 years. So,
it is no time to get out of Asia / China. Also, China has begun the process
of de-linking its currency, long discussed in this newsletter. That will
allow the US dollar to weaken against China and will mean appreciation in US
dollars for China stocks, even if there is no significant home market
appreciation.

PORTFOLIO PERFORMANCE AGAINST BENCHMARKS:

Annually I measure my portfolio performance against two benchmarks, the


Fidelity Freedom Fund 2020 (FFFDX, an asset allocation fund designed for
people like me, who will retire around the year 2020) and the Fidelity
Spartan S&P 500 index fund (FSMKX). Really a balanced portfolio, with its
lower risk bonds and cash should logically under-perform a higher risk
equity-only portfolio like the S&P500, but I still aim to beat the stock
market with my lower risk asset-diversified portfolio, by making correct
asset allocation decisions (picking the right sectors). Here are the past
eight year results. I have achieved my goal in each of the past eight years.
Though, this year my portfolio which was heavily in cash, benefited from the
sale of my employer and the subsequent exercising of my stock options. That
same stock (STIZ) hurt my performance in previous years, so I don’t mind
counting it now:
1999 2000 2001 2002 2003 2004 2005 2006
McMorris
FFFDX
FSMKX

PROGNOSTICATIONS for 2007:

The story line to watch in 2007 is “Where Goes the Housing Market”? If
housing bottoms soon and the Fed is able to keep the economy humming, with no
increase in unemployment and somehow with all the required economic stimulus
keep inflation low, then housing will recover and not be a story by year-end
2007. It may not be impossible, but it is a very tall order. More likely,
in my estimation, is the Fed will find itself in a corner and will not be
able to lower interest rates when needed instead holding the Fed Funds rate
at 5.25%. This could prevent the Fed from averting a significant economic
decline, because of its concern over inflation.

This lack of flexibility could lead to a harder landing for the economy, and
specifically the housing market, than hoped for. As discussed earlier, our
national debt has locked us into an inflationary future with the Fed working
hard to manage the inflation to acceptable levels. It is not just the
Treasury and our government doing the “deficit” spending. The public is also
borrowing and spending freely. Consumer spending has helped prop up the
economy the past 4 years since the 2000-2002 economic downturn. But now, the
consumer is fully indebted with no housing ATM to finance the debt.

How bad is the consumer debt fueled expansion in a historic context? Here is
a chart of government data on the average savings rate for Americans showing
the rate going negative in 2005 for the very first time in history:

Personal Savings Rate vs. 10 Yr. Treasury


(data from St. Louis Federal Reserve)
14.00
12.00 Personal Savings Rate

10.00 10 Yr. Treasury Rate


8.00
6.00
4.00
2.00
0.00
-2.00
Jan-59
Jan-62
Jan-65
Jan-68
Jan-71
Jan-74
Jan-77
Jan-80
Jan-83
Jan-86
Jan-89
Jan-92
Jan-95
Jan-98
Jan-01
Jan-04
Jan-07
Jan-10

Chart by "Wealth-Ed.com"
In 2006, the negative saving continued its downward trend and how is at –1.0%
(meaning that the public spends $101 for every $100 earned). This decline in
personal savings is really unprecedented in history. It is not known how
this will turn out. But it is only reasonable that there must be some period
of excess saving to offset the excess spending. What happens then is the
transfer from consumption to savings the dollars needed to balance the
equation. That will spell hardship for the economy. When will this happen?
Again, it is hard to know. The Rest of the World continues to finance and
encourage American consumption, to aid their domestic economies and further
full employment. American consumption puts people to work in China. So,
this phenomenon may continue for some time to come.

Because the declining housing market will impair the American consumer, the
burden to maintain economic growth will fall to the capital goods sector.
The good news is that a weakening American dollar encourages capital goods
export as much as it discourages consumer product import. America remains
(for now) the world leader in technology innovation. Capital equipment
benefits from technology improvements, so America should be able to supply
the global economic expansion with equipment and engineering expertise.

I update the following chart each year to draw comparisons to previous


economic cycles that experienced the same economic rotation from one sector
to another. History does repeat its patterns because they are based on human
nature, which does not change.

10000
2006 brings secondary
correction followed by
new Bull?

1000

Dow Ind 1925-1940


Pre-Election 1935-36, Dow / NASDAQ 1967-1982
1975-76
NASDAQ COMP 1995-2010
100

Primary Market Decline


(post election) 73-74, 30-
32

10
Jul 1924 Jul 1929
Jan 1967 Jan 1972 Jul 1936
Jan 1995 Jan 2000 Jan 1979 Chart by "Wealth-Ed.com"
Jan 2007

The 1920s and 30s were punctuated by the Great Depression that was
exacerbated by a housing crisis in the early 1930s. The late 1960s
experienced a technology boom similar to the 1995-2000 period that ended in
an Oil Crisis in 1973/74 which then precipitated a period of high inflation
in the late 1970s and early 80s. The major elements of each period are
almost identical in amplitude and duration (I have used a logarithmic scale
to demonstrate this phenomena). As with any physical upset, there is first
wild gyration followed by a significant period of stabilization, followed by
a gradual recovery period (starting slowly, and then accelerating into
another frothy period 20 years out). The chart shows we are ending the
stabilization period and heading towards a possible long-term upward period
starting between 2007 and 2010.

What happened to the USA stock market in 2006 and where does it go from here?

Another chart I use to show historical trends is focused on the idea of


“Channels”. Market trends tend to move within a channel on either side of a
trend line representing a price average over a period of time. The trend
line and its associated channel only change slope at significant points in
time, such as the Great Depression or the Oil Crisis. This market analysis
shows we are in a flat trend coming off the Tech bubble blowoff, perhaps
moving on up beyond the upper boundary that was at 11,500 on the DOW
Industrial index. In the past three months we have moved to 12,400, which

100000

10000

Dow Ind 30 - Red channels show


Real GNP 20 Yr. trends.
- Blue arrows show
average slope of
major bull market and
acceleration to the
late 1990s bubble.
- Pink arrows show
long term slope of
GNP growth and
sustainable market
slope.
1000 - USA Stock Market
in 2007 is breaking
out of the sideways
channel since 1997.
If it continues
breakout over next 2-
3 years, it can
challenge upper limit
of growth channel at
Dow 20,000 in 2008,
otherwide, 7500
continues to be the
lower limit in trading
range

100
Jan-67

Jan-72

Jan-77

Jan-82

Jan-87

Jan-92

Jan-97

Jan-02

Jan-07

Jan-12

Chart by "Wealth-Ed.com"
will either establish a new upper limit to the flat trend channel, or will
represent a breakout to a new upward sloping channel.

Technical analysis suggests we should have had to retest 7500 DJI, if this
were indeed the lower limit of the channel, reached last in early 2003. It
may be that 10,000 was the more reasonable lower limit as the market trended
between 10,000 and 11,500 for several years. If so, then the test of that
line in mid 2005 was the beginning of a new upward trend.

The pink lines are parallel to the slope of GNP growth the past 20 years.
The steeper GNP growth in the late 60s to late 80s was due primarily to
inflation that was above the long term average. Over the longest periods,
per capita GNP for a mature economy like America’s will grow at around 1%,
which can be attributed to improvements in productivity, aka technology. All
other growth is due to inflation that does not generate any economic
benefits. The stock market will grow only as fast as GNP plus average
inflation over the longest periods, or around 3 to 4% per year (the Fed’s
target for a stable economy), plus a risk premium that varies with time. The
risk premium is as low as 1% and as high as 4%.

The light blue lines show stock market growth rates above trend (steeper than
the pink lines). That rate is not sustainable and will result in a
correction when experienced. Over long periods, the stock market will average
the same growth rate as the economy. This chart helps us to recalibrate
reasonable expectations.

Another useful chart because it has a strong fundamental basis is the


“Presidential Cycle” chart. It is very instructive primarily because of the
power that presidential politics has in the economy. The President, through
Congress, is able to have very positive or negative effects on the economy
through taxation and spending policy.

Compare the “History Repeats” chart with the chart of the Dow 30 average for
the past (18) Pre-Election periods. It shows the benefit that is derived
from positive efforts by the incumbent government to stimulate the economy.
This average picture of the market is also identical to both the pattern and
size of the past actual 18 months in terms of appreciation of the Dow 30
averages:

Dow 30 Performance -
Average of past (18) Pre-Presidential Elections
20.00%

15.00%

10.00%

5.00%

0.00%
1 3 5 7 9 11 13 15 17
Months Chart by McMorris F.P.
In 2007 we move into a “pre-Presidential” period by July. It is one of the
reasons I forecast the market recovering its first half correction during the
3rd quarter. On average, the following 12 months (until July 2008) see a 17%
market appreciation. Note the yellow circles on the “History Repeats” chart.
The circles are the 18 month periods before a Presidential election (1935-36,
1975-76 and 2007-).

On the other hand, the 18 month period we have just completed, the Post
Presidential Election period, often results in a negative or flat market
period. We experienced that from January 2005 till the middle of 2006.
Then, on cue, the market began its upward move into the 2008 election, though
10-15% corrections cannot be ruled out, especially early on as in the first
and second quarter of 2007.

Dow 30 Average -
(18) Post Presidential Elections
5.00%

4.00%

3.00%

2.00%
1.00%

0.00%
1 3 5 7 9 11 13 15 17
-1.00%
Months Chart by McMorris FP

My Forecast for 2007

Based on the above historical and current events analysis here is my game
plan for 2007: A range of 10,500 to 13,500 for the DOW (a move out of the
range established the past nine years since 1998). We will see a range of
1200 to 1700 for the S&P500 and 1500 to 2300 for the NASDAQ Composite. I
think that the weakness this year will come in the first half of the year
with a bottom during the summer coinciding with acknowledgement of the mild
recession brought on by Fed Funds rates held between 5% and 5.5%. After
that, the pre-election fiscal stimulus, will cause a market rally during the
summer and fall. This will defy the conventional wisdom of a weak September
to October period for the second straight year.

Asset Allocation:

Asset allocation / diversification, along with identifying the best sectors


and skewing the portfolio to those sectors are the key to financial success.
I learned this lesson in 1997 and 1998 as my relative performance showed. I
badly under-performed the late 90s market by having my eggs in too few
baskets (too much STI company stock) and also being overweight the wrong
sectors (commodities, value and REITs before their time).

Here is my relatively conservative “base” asset mix: 60% stock, 20% bonds,
10% real estate (excluding our home), 10% cash. In 2006, I changed this mix
for the first time in seven years by decreasing bonds to 0%, reducing the
overpriced real estate segment to near 0%, increasing cash or stable value
money market funds to 40%, and maintaining most of the 60% equity weighting
in energy, international and small cap value.

Equities / Stocks:

Stocks rotate by cap size along with the economic cycle. Historically, the
rotation begins with Small Caps at economic recovery (more nimble) and moves
to Large Caps (better global exposure and able to acquire small caps as the
business cycle generates cash flow). There is also a rotation in terms of
risk, from Growth at the beginning of an expansion, to Value at the beginning
of a contraction. Stocks can be lumped by industry or sector into these
groups of value vs. growth and small vs. large cap, to assist with the
selection process.

The current environment favors large cap value, or at least Growth at the
Right Price (GARP) stocks. A GARP Stock will have a Price Earning ratio
divided by growth rate of less than 1.2. Good candidates in 2007 by a stock
screen with minimum $20B cap size, High ROE, and a P/E ratio that is right at
or less than the forecast growth rate. This screen will generate stocks with
a Low Cash Flow multiple and Low Relative Strength (to capture out-of-favor
stocks) accounting for the low PEG. First, let’s see how the 2006
recommendations worked out: Diageo (DEO) 39.0%, Annheuser-Busch (BUD, note
Warren Buffet is accumulating this company) 16.7%, Exxon (XOM) 36.9%, Johnson
& Johnson (JNJ) 11.8%, Coca-Cola (KO) 23.4%, Merck (MRK) 40.1%, Altria (MO)
18.4%, Wyeth (WYE) 12.8%, Conoco-Philips (COP) 25%, Pfizer (PFE) 15.5%, Dow
Chemical (DOW) –6.1%, Dupont (DD) 18.3%, and Verizon (VZ) 32.4%.

On average, that was a pretty good list. The list will be similar in 2007
but the highest gainers will not repeat in 2007, the consumer staple and
telecom stocks. Here is the stock list for this coming year: Johnson &
Johnson (JNJ), Merck (MRK) 40.1%, Wyeth (WYE) 12.8%, Pfizer (PFE) 15.5%, Dow
Chemical (DOW) –6.1%, and Dupont (DD) 18.3%, are retained and we will add:
Home Depot (HD), Aetna(AET), Aflac(AFL), Texas Instruments(TXN), CSX
Rail(CSX), Target(TGT), Walmart(WMT), Applied Materials(AMAT), Burlinton
Northern(BNI), Genentech(DNA), Intel(INTC), Johnson Controls(JCI) and United
Healthcare(UNH). The stocks are in sectors that did poorly in 2006:
pharmaceuticals, chemical, semiconductor, transportation (dropping the past 2
months) and discount retail. Because there might be a correction soon in the
market, it would be good to buy 1/3 now, 1/3 in May, and another third in
September, but many of these stocks have already been corrected and won’t
fall hard in any case.

There are several established and highly regarded mutual funds covering these
same stocks. Several good and diverse funds are with 2006 performance:
Vanguard Value (VIVAX, 19.3%), Dodge and Cox (DODGX, 16%), Clipper (CFIMX,
12.8%), American Funds’ Washington Mutual (WSHFX, 16.2%), and Oakmark (OAKMX,
15.6%). We can now use Exchange Trade Funds (ETFs) to select sectors. A
good ETF for large cap value, based on its low annual expenses and large
cross-section is: Russell Value 1000 (IWD, 21.37%) or DVY, (18.81%).

There is also a need for some small cap stock exposure in any portfolio. I
choose to change the allocation based on place in the investment cycle. Now
should be the worst time for small caps after seven years of outperformance
since the early 2000 decline in large caps. Since small caps are hard to
pick, unless you know something about a company based on personal experience,
it is good to use mutual funds or ETFs for small caps. As mentioned, two
good ones (according to Morningstar) that I have owned are Neuberger Genesis
(NBGEX, 8.3%) and Fidelity Low Price (FLPSX, 15.6%). There are several
others that can be researched by using Morningstar. Look for low volatility
(beta) and high relative return. Again, we now have an index ETF to help us
in this category. I suggest: Russell Small Cap 2000 (IWM, 16.87%). There
are also Value and Growth only versions of this Russell indexed ETF series.

Emerging Markets: This is a stock (and bond) theme that should be playing a
large role in any portfolio (5-10% of total). Emerging markets are the
source of future long term growth in the world economy. They provide a good
hedge against dollar weakness, and will increasingly provide a hedge against
the domestic economy (as Asia, for example, becomes a net consumer of
products). The best way to play the Emerging Markets is with managed funds.
“Emerging Markets Fund” (EMF, 23.5%) has a broad EM scope and provides
exposure to East Europe and Russia. We also now have the option of (EEM,
28.64%) which has been a very good choice. (TEI, 14.5%) is a closed end bond
version of the Emerging Market funds, better this year than last as the
dollar weakened. Pimco also offers a good emerging markets bond mutual fund
(PAEMX, 8.4%). There is also a Fidelity bond fund for foreign emerging stock
markets, with a (FNMIX, 10.9%) ticker.

“High Beta” / high return stocks: A small dose of speculative, “high-beta”


stocks can add some performance to one’s portfolio. An industry that has
many stocks that fit this requirement is Biotech. If you look at investing
themes that will do well over time, the first thing to consider is the
sectors that are driven by basic human needs.

The best time to buy high-beta is normally at end of a recession, Biotechs


and small tech stocks can be hazardous to the investor’s health at the top of
a market cycle. They are extremely volatile which is the source of the tag
“high beta”. Maybe only one of ten biotech companies will actually produce a
viable medicine. No one, not even the founders of the biotech, knows what
the successful compounds will be. The Biotechs were flat in 2004 and 2006
and had small to very good gains in 2005. During the same period, biotechs
have fared much better than large cap pharmas, which until the second half of
2006, had price declines due to patent expiration and litigation. Biotechs
are cheaper today than they have been since 2002. A good biotech ETF that
owns many companies and is capitalization weighted (and includes profitable
Amgen, Genentech and Biogen) is either Ishares’ (IBB, 3.68%) or HOLDRS (BBH,
-6.61%). The difference in the 2006 return between these two similarly
structured ETFs shows the degree to which active stock picking matters in
high beta funds. BBH tends to have the smaller caps, higher volatility so
does better coming out of an industry slump.

At some point in time, after the market has gone through the multi-year Bear
phase, small cap, high beta technology stocks will again be interesting, as
they were in the mid to late 1990s (peaking on March 10, 2000) and again in
2003. It is possible that later in 2007 may be another such good entry
point.

The “Hedge”:

I added stock options to my portfolio starting in the mid-year of 2004. I


continue using both option contracts and shorts to provide “insurance” for my
portfolio. Trading options is a difficult craft to learn and you are
competing with the best in the business. I make my share of mistakes, but
keep options exposure limited to less than 5% of my total portfolio as it can
be a higher risk approach to investing (done correctly, options will actually
lower portfolio risk). I had a slight profit on my options strategies this
year, but that includes owning put contracts (which expire at zero value)
that I am using for portfolio insurance. If I can insure my portfolio at
zero net cost, I am happy with that result.

I started the year using “Covered Call” options to take advantage of a rising
market and the option premiums that are available by selling Call options
against existing stock. I receive a premium or payment in return for putting
up my stock that will be sold at a predetermined price. But during the year,
price volatility in the market continued to decline. Option premiums are
highest when market volatility is high. With the current low volatility, it
has become increasingly difficult to find good returns (24% annual or better)
by selling covered calls, the most popular of option strategies for the
average investor.

Later in 2006, I began trying more complicated option strategies. One


strategy was selling naked puts that are Out-of-the-Money (OTM) by 5-10%,
which typically have higher premiums than a Call option on a stock at the
same expiration date and strike price. This is due to fewer participants in
the option (lower demand = higher premium). But selling naked puts carry the
risk of getting “assigned” requiring purchasing the stock when its price is
falling. I have been caught on the naked put strategy a few times this year,
but contained damage by holding the stock until the price recovered (which I
did in spades with Conoco (COP) in April and Apple (AAPL) in July). At
times, I also “rolled forward” the contract to a later expiration month, or
just took my lumps with a loss that will offset other gains for tax purposes.

Lately, because of my cautious posture on the overall market, I am buying


long term LEAP put contracts “In-the-Money” (ITM) rather than selling puts
one month out, which is a bullish strategy. By buying puts, I am making a
bet that a stock or the market will decline during the next 12-14 months.
The current low market price volatility makes buying puts less expensive and
also is an indicator for a possible correction. For this strategy, I
typically choose high P/E stocks like Amazon or broad market index ETFs like
S&P 500 (SPY) or NASDAQ 100 (QQQQ). If I think the stocks or index funds
will go up in the near term, I may sell an “at the money” put contract on the
same stock or fund to help pay the premium for the long term LEAP contract
purchased.

It is possible to hedge a portfolio with this strategy and rather than sell
the long positions in the portfolio, use long term option puts to protect the
portfolio. This strategy is also known as buying portfolio insurance.

Bonds:

During the current period of rising interest rates and the potential for
higher inflation, I have favored short term and inflation-protected bonds
(Treasury Inflation Protected Securities called TIPS) in past years. Since
TIPS are “real rate” instruments, with a guarantee of a nominal market return
over CPI inflation, the TIPS did not do well in 2005 or 2006, even compared
to a simple money market account. Vanguard provides the low cost TIPS fund,
(VIPSX, 0.94%). The return has been low this year, but is finally looking
promising for next at a lower price basis of $11.84 and with a current 6.0%
dividend rate.
Seeing the problems with TIPS, early this year, I moved out of TIPs and into
higher return “Stable Value” funds available with mutual fund companies, and
variable rate “secured asset” funds, ETFs “Closed-End” funds like Nuveen’s
(JRO 19.95%). Both Stable Value and Secured Asset funds purchase shorter-
term “commercial paper” that allow the investor to act like a commercial bank
loaning at or above prime. Because the paper has a short term or variable
rate structure, rising interest rates do not hurt its value. Stable value
funds also buy some short term government bonds to lower risk (source of the
“stable value” title) returns are near the 10 year Treasury rate, now at
4.6%.

Just like a bank, secured asset funds like JRO borrow some portion of the
money they lend and therefore have leveraged returns that exceed the actual
interest collected. They typically use very little government paper and have
somewhat lower rated commercial paper, if it is even rated (secured
commercial notes are not rated by the agencies like S&P because the secured
assets provide protection, making risk less than unsecured AAA). Closed-end
funds trade at premiums and discounts to the “Net Asset Value (NAV) of the
underlying financial instruments. It is my rule to never buy a C-E at a
premium, but only at a discount. About half the return on JRO this year was
due to the discount of 8% available early in January reducing to a 1.78%
discount as of 12/26/06. But it is still worth owning JRO for its 9%
dividend payout.

The downside of a fund like JRO will be experienced if there is a deep


recession that causes significant loan defaults. Unlike unsecured bond and
“junk bond” funds, some percentage of JRO’s secured debt will be collectible,
but it will get marked down. And because JRO is a closed-end, it will also
sell at a deeper discount to NAV, which will also hurt the share price.

Longer term bonds (over 3 years) should be avoided for the immediate future,
though, if 10 year Treasury bonds make a move to 5.5% (from 4.6%), it would
be a good bet to buy those, as the next move in interest rates would likely
be flat to down. But my bet is that inflation due to commodities and the
eventual devaluation of the USD is structural and baked-in. Inflation always
is poison for long bonds (10 or more years). Because the economy is likely
to weaken, high yield or junk bonds should also be avoided. They are still
at historical low spreads over safe 10-year Treasuries, less than 2.5%, as
has been the case for over two years. A good time to own junk bonds is when
the spread is over 8%, typically during a recession.

Real Estate:

Real estate has seen better times. It was at its best in the late 1990s when
the market thought the internet would replace the need for commercial real
estate. But since 1998, real estate has become expensive by most measures.
But there are many benefits to real estate under different valuation
circumstances. It has low correlation to the stock market, but a high
inverse correlation to level of interest rates. Real Estate Investment
Trusts (REITs) are the best way for the average investor to participate in
the real estate asset class. It is also possible to own individual
properties, but management of those properties requires time and effort.
Also, it is hard to gain adequate diversity by owning individual real estate.
A minimum of 15-20 properties in several geographic locations and different
property classes (e.g. apartments, shops, offices) would be required to
become truly diverse.
Because of the so-called “real estate bubble” in the housing market and the
coincident runup in the price of the average REIT, it is not a good time to
own REITs. REITs were yielding over 8% in the late 1990s, when the asset
class was out of favor. Subsequent price increases in REIT stocks (and their
underlying real estate) has reduced the return of as low as 1.29% (FRESX),
much less than many dividend paying industrial equities that often pay out
less than 35% of their cash flow. REITs, on the other hand, must pay out 95%
of cash flow according to the tax code. As the housing market has become
overpriced with the availability of low interest rates and high liquidity, so
too has commercial real estate market.

In a period with higher interest rates and less liquidity, and a less robust
business environment, rents and building occupancy will suffer. That will
drop the price of REITs and eventually set the stage for higher REIT yields.
This time is at least 2-3 years away. When that time comes, Fidelity (FRESX,
35.8%) and Vanguard (VGSIX, 37.6%) are good REIT funds, as is Cohen-Steers
Realty (CSRSX, 39.0%). The Cohen Steers REIT fund has a sister ETF fund that
can be traded intra-day (ICF, 41.7%). Fidelity introduced an international
REIT in 2005 (FIREX, 32.9). This might be a good place to pick up strong
real estate returns the next few years while hiding from a declining dollar.

REITs have returned well above their average trend line and the overall
market for the fifth year in a row. Returns have been 300% since January
2002. This cannot continue indefinitely and there will be reversion to the
mean. That will require a very big price drop. A price decline of 50-70%,
would return REIT prices closer to their long term total return trend line
(12% annual total return) and increase dividend yields to back over 6%, where
they were in the late 1990s.

Hard Assets / Commodities:

I have been promoting Oil as an investment now since 2002 (actually, I made
my first oil investment in 1997 with Freeport-McMoran with its 14% dividend,
but was very early on the secular move up. I sold that one for a small loss
when the dividend was cut to 4% during the oil price decline of 1998). In
the 2005 letter, I pushed the oil theme harder than ever and followed it up
with a repeat for 2006. If you went along with the recommendation, you are
today very happy. It turned out to be a solid bet, with average appreciation
over 40% in 2005 and 20% in 2006, depending on whether it was drilling
equipment, producers, natural gas or integrated oil stocks that were
purchased. This will continue to be a good market sector, all though there
may be a short term pull back early in 2007 if the economy sees a downturn.
That will imply lower demand, and hence a lower price for oil. However, the
long term trend favors much higher prices, so a pullback will create another
buying opportunity.

Matt Simmons is an industry expert who wrote a book last year called
“Twilight in the Desert”. He stated at that time in a Barron’s interview
(January 2, 2006 edition):

“I've placed a $5,000 bet (with a NY Times reporter) that oil prices
will average $200 a barrel in 2010. I don't have any idea where oil
prices are headed (next week) but they could easily be above $200 a
barrel. At $65 a barrel, or 10 cents a cup, we are still grossly under-
pricing oil, which is why it (high prices) doesn't have any impact on
demand. As the markets get tighter, sooner or later we are going to
have shortages. And the two times we have ever had shortages in North
America within 90 days, the price of oil went up threefold”.

Master oil investor T. Boone Pickens is also public with similar theses
regarding the trend for the price of oil, as is industry consultant Tom
Petrie and consultant Robert Wulff of McDep Associates (www.mcdep.com).
Energy should be a large portion of any portfolio for the next 10 years or
more, during the time Chinese and Asian economic expansion puts supply
pressure on marginal production.

Also in 2004, I began suggesting gold for the first time. Like oil, this
turned into a good bet and the gold thesis continues to look promising. Gold
bottomed at $250/ounce in 2001. Since then, it almost tripled to over $715
in May of 2006 but has declined to around $625 as of this writing. As
reported in 2004, gold has been the “Anti-dollar” since 1971, when the USA
went off the gold standard and onto a paper based standard (the USD).

Two years ago I wrote: “Even if the worst case does not come about (a dollar
collapse), it is likely that the Chinese must de-link currencies in the next
2-3 years (a process subsequently begun in 2005). Our problems are becoming
their problems. Our devaluing currency is expanding their money supply at a
time when the Chinese government would like to throttle back to avoid hyper-
inflation, over-investment and ultimately an economic crash. When China de-
links, it will cause their exports to cost more in USD terms, and we will
undergo accelerating inflation. The end result of these concerns is the need
to own either commodities (in the form of mining, energy or other natural
resource companies), and rare metals (gold, silver, platinum, etc) in
certificate or in fact.”

About this paragraph, I will not change a thing. In fact, the Chinese did
de-link in 2005 for the first time. They have elected to link to a “currency
basket” that they will not define. They will gradually decrease their
dependence on American assets. Because there are no other really good “fiat
currency” alternatives, I am betting they will be adding more and more
precious metals to that reserve basket. What does this mean for us as
investors? Vanguard Gold and Precious Metals (VGPMX, 35.1%) was recommended
two years ago in this space as a low cost way to get the needed exposure to
the precious metals that China will seek as part of its “currency basket”.
VGPMX has a current 3.3% yield. It returned 43.79% in 2005, well ahead of
actual gold. There is operational leverage in the mining stocks that
comprise VGPMX. The fund manager is also free to move between countries for
exchange rate advantage and types of precious metals depending on what is
most undervalued. Individual mining stocks like AU (-6.5%), Yamana (AUY,
89.9%), Newmont Mining (NEM, -15.0%), or the gold ETF (GLD, 19.52%) are also
available to provide a hedge against inflation. The volatility of the
individual stocks versus the funds argues for the diversification of funds.

The other important “Hard Asset” investment class is Energy stocks. Again, I
wouldn’t change anything, other than to recommend more natural gas and
producer stocks. We have had our pullback from the highs of $78 per barrel
of oil and $14.50 per million BTUs of natural gas ($62.41 and $6.64
respectively as of 12/22/06). Because of long term global demand and limited
supply the energy markets are set for a strong 2007.

The large cap integrated oils came through in 2006 for the first time in many
years, after being left behind by exploration / production companies in the
2002-2005 period. The integrated energy companies are disadvantaged in that
much of their oil reserves are in countries where the government receives a
large portion of the profits resulting from increasing prices over the
production cost. These same third world locations may even nationalize the
oil reserves and kick out the producing companies. So there is much risk
here. The best integrated companies own large domestic natural gas reserves
and refining capacity where margins are high. Most trade at less than 10x
earnings. Large cap integrated energy companies like Exxon (XOM, 36.9%),
Chevron (CVX, 32.3%) and British Petro (BP, 7.0%) may be the most exposed to
the negatives of this segment. Conoco (COP, 25.0%) which bought natural gas
producer Burlington Resources in 2005 and has a position in Russian oil and
gas, continues as a good bet. It has just had a terrific two-month run.

There are several diversified ETFs in this sector. (IYE, 19.73%) is a good
domestic and diverse choice with a 31.74% return in 2004 and 34.67% in 2005.
(IXC, 19.68%), up 26.47% in 2004 and 29.47% in 2005, provides more
international exposure, and possible benefit from the resulting currency
trade. (OIH, 9.77%) up 37.21% in 2004 and 51% in 2005 is focused on only the
energy equipment manufacturers. This provides a higher beta in the energy
group, which means higher return as long as energy does well. There are also
many energy mutual funds including the Fidelity Natural Resources, (FNARX up
18.82%) that also provides some mining exposure and Vanguard Energy (VGENX up
18.92%).

Throughout 2006, I added to my positions in oil and gas producers that trade
as “Canadian royalty” trusts. This proved a good move until September when
they began to decline as a group. At the end of October, we found out why.
The Canadian government announced it would change the tax-free status of the
royalty trusts and they promptly dropped by another 25% on average. Now that
the stocks have been revalued by the market, that risk is out of the price,
and all that is left is great dividends of over 12% per year and the
potential of appreciation as the tax situation works itself out. There is no
more downside as long as energy prices don’t collapse.

I increased my positions in the trusts by over fourfold after the re-pricing


to lock in the great returns with limited downside risk. I own Petrofund
(PTF) even after it was merged with PennWest, (PWE, 3.4%). I also own
PrimeWest (PWI, -29%), Penngrowth (PGH, -17.3%) and Provident (PVX, 12.6%).
All should do better in 2007 while providing a terrific dividend pay out that
is now over 12%. The high dividend pay out makes them best for tax
advantaged accounts like IRA or 401K. They will continue to perform well as
their domestic North American oil and gas reserves gain in value. They are a
strategic hedge against more trouble in the Mid-east. If you buy these,
don’t forget to take the Foreign Tax Credit on your tax return, for the 15%
tax currently withheld on dividends by the Canadian government.

Cash:

Cash is good. The good thing about the 17 consecutive increases in the Fed
Funds rate is that it has brought a decent rate of return back to money
market funds and other short term bond funds like stable value. Now, you can
get 4.5% sitting on your cash until the next buying opportunity in the stock
market. Have a lot on hand for investing opportunities later in 2007.

Have a Prosperous and Secure 2007.

Brian McMorris

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