email:                         phone: (248) 835-9112                            fax:(419) 858-4570                       2139 Brinston Dr. Troy, MI 48083
Katto Financial LLC                                     News Letter 10/07/06  


The Economy:

The Fed left interest rates unchanged during its meeting in September. There was further evidence that the economy has slowed down and inflation is under control. Some economists are projecting that the Fed will need to lower rates as the economy may be entering a recessionary phase. Other economists are pointing to stagflation, a period of inflation (rising prices) coupled with a slowing economy. There would be no easy cure for stagflation as raising interest rates to fight inflation slows the economy further. The good news on the inflation front is that oil prices have come down from a high of $75 in July to $59 last Friday. All of the risk premium and the hype that has been generated around that risk is fading away leading to lower prices dictated by supply and demand. There have been no damaging hurricanes, the Israeli-Lebanon war did not spread to the rest of the Middle East, and Iran is toning down its rhetoric. Some OPEC countries are pushing toward an oil production cut to stop the slide in oil prices. The drop in oil prices has been great news for investors. 


As I have pointed out in previous news letters, oil is the most influential factor in the economy and oil prices directly impact stock price performance. As a result the stock market has been on fire lately. The DOW and S&P have reached new all time highs. The NASDAQ has recovered as well but is no where near the 2000 bubble high of 5000. See charts below. The NASDAQ is still undervalued while the DOW and the S&P are fairly valued at this point. Keep in mind that valuation is in the eyes of the beholder and depends on future earnings estimates. High estimates lead to low valuations and vice versa. Diversification is the key to a healthy portfolio. Placing all eggs in one basket can be disastrous to your financial health. Charts cannot predict one time bad news events. GM for example has been on a tear in 2006 until last Friday when the market perceived the departure of Jerome York from the BOD as bad news for shareholders. Similarly, Infospace announced that Cingular, a major customer, will be cancelling the ring tone contract next year which is a blow to earnings estimates for 2007. Recent market upswings have lifted all stocks. However, technology stocks in general did not participate in the recent rally. I believe that large cap and mid cap growth mutual funds dominated by tech stocks represent a good value.



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