More volatility, fear, and bad news regarding subprime mortgages continued to rattle US markets. For much of the past three years, pundits had split opinions regarding whether rising home and oil prices would effect core inflation. They never did. Now, the question du jour is if housing and mortgage market problems will dampen the broad economy. Current studies indicate that although a sizeable percent of recently issued mortgages may end in foreclosure and unfortunately a large number of people will lose their homes, the overall loss to lenders and investors will be small once the properties are resold. Easy credit facilitated the housing boom and concurrent run-up in prices. With the current subprime collapse and increase in delinquencies, we have already entered into a corrective phase – with declining prices, rising inventories and higher credit standards – that may be over by late 2007 or in 2008. The climbing delinquency rates are scaring the market, but Fed Chairman Ben Bernanke, as well as various law makers, will probably take steps to prevent a wholesale collapse in housing prices. Ironically, because the Fed would never tighten credit during a financial crisis, the mortgage predicament may end fears of higher Fed interest rates and in that way be a positive sign for the markets.

Corporate mergers and private equity buyouts continue to prop global stock markets. Deal makers broke the record for mergers and acquisitions last year and 2007 has started even faster, 25% ahead of last year’s pace. In addition – helped by a weak dollar – US exports are booming. Based on robust labor markets and spending indicators, American consumers are also remaining active, even with the loss of housing confidence. For all the fear and negative sentiment in the market, most domestic economic cylinders are firing.

Closed-end funds (CEFs) of overseas stock and bond markets still offer enticing opportunities. The equity markets of Japan, Sweden and the Netherlands offer long term value, as does German and Asian Real Estate. In addition, Emerging Market (EM) credits should continue to hold value and EM equities should advance. There is strong potential for these international equity and fixed income markets to outpace the US over the next year. More importantly, we believe that the volatility inherent in these markets combined with the structure of CEFs will create multiple arbitrage opportunities.

Michael Ashley Schulman, CFA
Hollencrest Capital Management