PORTFOLIOS

Let's start with the brief summary of Vega's Portfolios. While being cautious for the past several months, we have enjoyed a significant recovery in both our Vega Equity * ™ Portfolio (at the end of the III Quarter we were up approximately on par with S&P — for details please see the attached reports), and in our Vega Safety Portfolio due to a huge run up in bond prices. Our new program, Vega Inevitable has performed as expected and benefited from the rise in commodity prices, in particular gold and silver.

OUR VIEW OF THE MARKETS AND ECONOMY

Monetary Policy

First, a few obvious (and not so obvious) statements. We (as in "world economies") have avoided a structural collapse of financial institutions. Of course, being in crisis mode for the past year, it has been very difficult for major central banks to conduct normal monetary policy. Interest rates are near zero. And we have to admit — the results have been clearly very positive. However, at some point Central Banks will have to raise interest rates to avoid risking runaway inflation. Some serious questions remain — after expanding their balance sheet to record levels, are there any technical difficulties in reversing this process? What about the timing? We expect quantitative easing to come to an end in coming months and expect the rate hikes to start in the second half of the next year.

Some statistics. The World Economy has approximately $60 trillion of wealth available for investment, a pool of capital that is expected to grow by approximately $1.5 trillion next year. That's the good news. The bad news is that between now and then the Obama Administration needs to sell about $2 trillion of Treasury paper to cover the economic stimulus program and related federal deficits. Who is going to buy it?

Foreigners already own roughly 43% of the $7.5 trillion in publicly held Treasury debt, lead by China with $750 billion. Some estimates show that by 2026 foreigners will have to pour ALL their incremental savings into U.S. Treasury paper. It is highly unlikely they will do that. On the other hand, it is absolutely obvious that to finance all its programs, the US Government will have to convince foreigners to hand over more of their cash than ever before. The inflation has clearly bottomed in many countries in July and is likely to rise substantially in coming months — this is the ultimate price we will all have to pay for the stimulus programs, rebate programs, TARP, TALP, Cash For Clunkers, and the others being implemented by the US Government.

Markets

What do we know about how the prices of goods and of financial assets are arrived at and determined? Indeed, very little. We know that prices of assets can diverge from their fair price by a long way and for extended periods (yes — please think end of 1990's in one direction and 2000-2002 in the other). Expectations become disassociated from reality, particularly in periods of growth combined with relatively low interest rates. Behavioral finance is the field of study that tackles these questions.

Bernard Baruch, a stock market speculator, statesman, and presidential advisor to Woodrow Wilson and Franklin D. Roosevelt, once said, "When good news about the market hits the front page of the New York Times, sell." Forty-four years after Mr. Baruch's death, never has his advice been so sound.

The third quarter trailing 12-month S&P 500 earnings will likely be 46% lower than 2007's peak levels. This is much more severe than the average 14% decline in earnings from the peak to the end of the recession that we have seen in the average downturn since World War II. Markets, however, reflect a full-blown, full-scale speed recovery. This is highly unlikely from our point of view.

Economy

In our previous newsletter we have posed some questions and we did not have clear answers. Even though the complete collapse has been avoided, we still do not know the price we will pay for the unrestricted spending (please, see the paragraph on Monetary Policy). The main question which remains unanswered now: will we have a double-dip? From our point of view, this would be historically unusual and is likely only if there are exceptional adverse factors, such as a debilitating credit blockage. So far, there is a little evidence of that, but we cannot completely rule that out.

According to most of the economists, the unemployment will continue to rise — granted with slower pace, and it already has significant impact on consumer spending. Combined with the mantra of American Society — save, save and save, this will have a significant impact on how fast the economy can recover.

HOW WE POSITION OUR PORTFOLIOS

Fixed Income Portfolios

Bond prices are likely to fall as the global economy improves further. As the economy is shifting from stabilization to an early stage of recovery — and it will be very gradual — this is a typical phase when equity prices move rather sharply higher and bond prices — lower. Equity prices have already delivered their part of the historical pattern, while bond prices still remain high. We might want to reduce our holdings in long-term obligations in favor of shorter term maturities and inflation-protected instruments (such as TIP's).

Equity Portfolios

THE RISKS HAVE FALLEN, NOT DISAPPEARED.

Our strategy of avoiding the troublesome sectors (including financials) might not capture a huge upside in financial stocks but avoids, from our point of view, the undue risk, still present in the market. If this is a real recovery — we will have plenty of time to capture the upside. However, if all the data cited above will start to reflect in equity markets, we will see a decline in equity values. We still have a significant portion of our portfolio in energy stocks, precious metals, biotech, and have some cash holdings to be deployed at the opportune time. The rest of the positions are distributed between some major industrial companies (beneficiaries of government programs), and hand-picked ideas which we have (watching movies at home — you know the company — is one example). Given ongoing economic growth, we will continue to overweight commodities strategically. Given a recent run-up in prices, our tactical positioning will be slow.

We are patiently waiting for the prices of certain companies we want to acquire for our equity portfolios to come back to sanity — we feel that while these are good candidates, the prices are too high and have gone up too fast for our taste. We are reasonably happy with the upside we have been able to capture and exercise EXTREME caution now. All liquidity rallies end with corrections — and this one might not be an exception.

As always, we welcome any phone calls, e-mails and requests for meetings to review the portfolios. Do not hesitate to call us to discuss any concerns you might have.

As usual, we always appreciate the referrals from our happy clients.