email:                         phone: (248) 835-9112                            fax:(419) 858-4570                       2139 Brinston Dr. Troy, MI 48083
Katto Financial LLC                                     News Letter 09/04/06  


The Economy: 

Stocks are staging a come back after recent economic indicators have shown that the rise in interest rates has slowed down the economy and lowered inflation somewhat. The Fed has succeeded in engineering a soft landing. In its last meeting, the Fed took a wait and see stance. Recent economic data has indicated that unemployment is still historically low and core inflation is under control. The majority of economists agree that the Fed is either done or nearly done raising rates. Despite many interest rate hikes the past several months, Interest rates are still historically low. It is my view that the economy is still humming and will continue to hum along as long as the following economic risks do not materialize: 

a) A terrorist attack.
The foiled terrorist threat in August to blow up airlines destined to the United States in mid air is a reminder that terrorism has not stopped and continues to threaten the economy. If terrorists succeed, we can see an economic impact just as we did after 9/11. We will see a slow down in travel and tourism and a ripple effect that will lead to lower earnings and lower stock prices. The impact will be less severe than the after math of 9/11 as the world has gotten used to terrorism and will recover quickly.  

b) An Iran showdown. The Iranian government continues to defy the international community and has rejected many incentive offers by the EU to stop development of nuclear weapons. The recent Israeli-Lebanon war has shown the world that Iran is a major player in the region and will be an even bigger threat if it had nuclear weapons. There may be a point where talks will stop and a military action may be taken by the West against Iran. President Bush has repeatedly stated that Iran will not be allowed to develop a Nuclear weapon. Spokespersons from both houses have reiterated President Bush's position. Today the Democrats criticized the President for not taking a more decisive stance against Iran. It is my view that a showdown with Iran is very likely and an oil price spike and a major short term setback to world markets will follow. The severity of the impact will depend on the impact of reduced oil flow from the region to the world. Iran has threatened that it will shut down the straight of Hormuz. Such a threat is very serious and should not be taken lightly as the majority of oil flow from the region comes via tankers crossing that straight. Iran may also stop production and shipment of oil which in itself would be a major blow to world markets. Remember that oil is the bloodline of the world economy. It is a component of every product and service in world economies. 

c) Hurricanes in the Gulf of Mexico damaging oil platforms and refineries in the Gulf and nearby States. Although the
Hurricane season has been benign so far, no one knows for sure what mother-nature has in store for us. The Hurricane season lasts until mid November. 


Many economists point out an election year that will end up in the Democrats controlling both houses as recent polls
have indicated. It is my view that the election will not have a long-term effect on stock markets as long as the economy continues to grow and there are no policies that impede economic growth. While Republican policies of low capital gains taxes, low estate taxes, and lower income taxes have been good for investors for the last 6 years under President Bush, President Clinton presided over a healthy economic expansion during his two terms. While the transition may be an uncertain time for the markets and the markets hate uncertainty, it will be a short term event as the markets will get used to the new establishment in time. 


Stocks staged a comeback and are still trading at low estimated multiples and are undervalued. However, given the risks above one should be careful having too much money invested in stocks. A diversification strategy and a balanced portfolio are important. A well diversified and a balanced portfolio of stocks, bonds, and cash is the best way to play the markets. Timing the markets has been proven to be a failed investment strategy. Remember that investing should be for the long run and any short term drop in world markets will be an opportunity to average down the purchase price of stocks or mutual funds.   GM has been a star performer in 2006 as the turn around strategy being implemented is showing positive results. It is my view that barring any oil crisis or any breakdown in the Delphi/union negotiations, that GM stock will continue to rise. GM employees should not invest more than 5% of their portfolio in GM stock as they have invested their careers and their retirement in GM already. 

Disclosure: I am a GM employee and own a small number of shares of GM stock.    

Mike J. Katto

Registered Investment Advisor

email:                         phone: (248) 835-9112                            fax:(419) 858-4570                       2139 Brinston Dr. Troy, MI 48083