email:                         phone: (248) 835-9112                            fax:(419) 858-4570                       2139 Brinston Dr. Troy, MI 48083
Katto Financial LLC                                     News Letter 12/29/06  


The Economy:

Economic data continue to support the view that the economy is growing at a slower pace with conflicting inflation data in December. The CPI data in December was tame but the PPI data showed a high jump in prices which concerned some economists and led them to think that the Fed may not lower interest rates in 2007 and may actually raise interest rates. In my view, the Fed is not likely to do anything with interest rates given current data as not all indicators show an inflationary economy. Consumer confidence is high, unemployment is low, and corporate profits are at record highs. Oil prices have stabilized at the low 60's support. The risks to the economy are geopolitical. Iran continues to be the greatest risk with its threat to reduce or stop the world oil supply and its nuclear ambitions. Also, potential terrorist attacks are a risk to the economy as well. Barring materialization of any risks, the economy will continue to grow in 2007. Despite the steep rise in stock market averages in the second half of 2006, most economists believe that the markets are still undervalued and will go higher in 2007. I support that view as well. 


Democrats are blaming Republicans for the war in Iraq and are calling for troop reductions and withdrawal. President Bush continues to push for a continued presence in Iraq. There is no clear Iraq strategy yet. The Iraq war is important as the outcome of that war impacts the two economic risks I mentioned above: the world oil supply and potential terrorist attacks. The political gridlock that is expected in 2007 will be inconsequential to the economy and the markets. 


2006 was a very good year for stocks. See chart below. The Dow and the S&P 500 reached all time highs in 2006. The Efficient Market Hypothesis (EMH) that supports investing in index funds is validated by the results in 2006. Despite the market downturns in previous years, having invested in index funds would have returned a positive return over the years. GM was the highest performer among the Dow 30 stocks and had a 60% return. Technology stocks such as Google, Microsoft, and Cisco systems had good returns as well. A well diversified portfolio of stocks, bonds, and cash will do well in 2007.   

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