The answer to all of the above questions is "yes." If you think this answer is contradictory, you are right. We are getting contradictory signals again and again. The Michigan confidence index is up more than expected, which means we are spending, right? Wrong — savings rates are up. Housing is recovering, right? Wrong — banks are holding up inventories in order to prevent further price declines. Ken Lewis from Bank of America was threatened by Bernanke, right? Wrong — Bernanke said he did not. Right? Wrong? Nobody knows.

Let's try to analyze facts, not emotions.

What is the root of all the problems? As we discussed in our previous newsletters, it is now obvious that the astonishing housing bubble could not have occurred without the Federal Reserve's easy money policy which got under way in late 2003. If not for the excess liquidity created, there would not have been sufficient fuel to distort the housing market and ultimately the entire financial system. "NINJA" loans (no income, no job, no assets), combined with "greed" lead to excessive spending. It is amazing that now everybody understands that while one year ago nobody did.

We are now witnessing a new wave of mortgage defaults. House prices in America have fallen so far that as many as one in five households have a mortgage debt greater than the value of their home. Therefore, some homeowners may be tempted to default and escape the burden of negative equity. Just how widespread is this practice? New research based on a recent survey shows that one out of every four households would STOP paying their mortgage even if they could still afford it!

So, where do we stand? We are trying to weigh the positive and negative signs to accurately position our portfolios. Here is our thinking process in a nutshell:

Troublesome signs:

1. Executives at U.S. Companies are currently selling their shares at the fastest pace since the credit markets started to seize up two years ago, according to Bernheim, Dreyfus & Co.
2. The situation with unemployment is very unclear, and the "official" statistics does not present the entire story. According to David Rozenberg, if you take into account all the part time-workers and all "disenchanted workers," then the real rate of unemployment is close to 16%!
3. We also received business sales data for May — this is a proxy for nominal GDP; it declined 0.1% during the month, and is falling at an 18% YoY trend, which is without precedent. The economy is clearly still in a recession. Excluding auto, the sequential decline was 0.3% and the YoY slide was 17.3% — a record as well. So the quick answer is "no" — this is not just an automotive story, it's rather a broad-based economic recession.

A Positive Sign:

The silver lining to the cloud above is that large companies have been able to take advantage of investor enthusiasm to raise money in both the bond and equity markets. Not surprisingly, Goldman Sacks have announced record earnings: between free money from the government, Mr. Buffett's money, and the "proprietary trading," they have record earnings.

So, is the worst over, and is the recession over? While we believe (please see our previous newsletter) that we have avoided the cataclysmic scenario and saved financial institutions — let's give credit to the government here — we do NOT see signs of economic recovery. What we see are signs that the deterioration of the situation is slowing down. Therefore, we consider the recent market run as the Bear Market Rally, and remain extremely conservative in our portfolio construction as evidenced by the ever-increasing number of covered calls in portfolios, hedging instruments (such as S&P puts), large positions in Gold and Silver, and anti-inflation positioning in our significant exposure to oil related stocks. While we risk missing a certain portion of the rally (if it ever materializes), we would rather be on the safe side.

As far as the performance of our Vega Equity * ™ Portfolio, we continue to outperform the S&P 500 by several percentage points. Of course, you will receive individual performance reports together with this newsletter.

As usual, do not hesitate to call us with any questions you might have.