Absolute Return Portfolio Management LLC

Latin American and Emerging Equity Markets Very Overextended

Gold Rally Mini-mania Poses Downside Risks

Yield Curve Will Shift Higher & Flatten

US Dollar Rally Intact - Broad-based FX Decline Accelerates

The intermediate-term outlook for the next several months remains one of higher risk. Last week's decline created a short-term oversold condition in the market leading to a bounce so far this week. Hurricane Rita was, quite fortunately, not as devastating as many feared so we are getting a "relief" rally.

This short-term bounce may see a possible retest of recent highs or may just consolidate for a week or two. Following that I expect another, more severe, leg down in the decline. The modest price decline that has occurred so far has yet to resolve the intermediate-term overbought condition.

Absolute Return Portfolios do not have any equity exposure at present. I expect to establish Market Neutral and outright short positions soon.

Latin America (LATAM) and Emerging Market equities remain superior long-term alternatives to domestic equities but are dangerously overextended. Every market top has its "fad" or "hot sector". LATAM is fulfilling that role with flying colors...beware of massive downside air pockets!

There is too much bullishness surrounding the Yen and Japanese equities. Any global equity market weakness will be compounded by currency losses in the Yen which remains in a bear market.

Lack of leadership from the NASDAQ and Small-cap areas serves as a warning from these previous domestic market leaders.

Consumer Discretionary stocks, which represent "big ticket" purchases, and Retail stocks are sectors institutions invest in when they anticipate a strong economy and equity market. The fact that these sectors continue to perform badly suggests anticipated retrenchment by consumers and slower economic growth.

The defensive sectors, like Consumer Staples, Utilities and Industrials, are gaining strength and show a rotation by institutions to sectors that protect portfolios from anticipated market weakness.

The yield curve is about to flatten and shift higher across all maturities. In other words, we will see short-term interest rates increase rapidly. Long-term rates should also shift higher. Near-term inflationary implications of higher oil and increased government spending are the catalysts.

We remain on a SELL for both domestic and international investment grade bonds. We do not own any International or Domestic bonds in our Absolute Return Portfolios. Conditions supporting a SHORT SALE are building, however.

We remain on a SELL for the DOMESTIC High Yield segment. Today, I am also moving Emerging Market Debt to SELL because this area is also quite vulnerable to the anticipated equity market decline and we could have a market break before our next publication. I am very close to shorting domestic High Yield Bonds.

Actual credit default risk is very poorly priced today. It's not a stretch to say that high yield bonds are priced like Internet.com stocks in March 2000. In other words, too much good is expected for the future with little appreciation of the risks.

The potentially adverse impact of a credit derivative "accident" somewhere in the hedge fund or banking area make the high yield and Emerging Market Debt areas quite risky. The scapegoat will be the option models used to price these OTC derivatives. These models very poorly model real- world default risks and systematic shocks. The result is that risk is very under-priced. This type of condition can result in sizeable declines as true risks are realized and priced accordingly.

Technical and valuation models for gold/gold equities show a market that is very overextended and subject to a significant intermediate-term decline. Though gold and gold stocks could go higher, the risk/reward doesn't favor long positions at present.

We are flat gold and gold equities and would recommend tight stops for any longs.

Crude oil remains in a long-term bull market. My proprietary Commitment of Trader Reports (COT) models are now indicating potentially higher crude oil prices over the coming months too.

Higher crude oil could prove to be a potentially devastating event for the bond and equity markets as it could create a capitulation among those that have viewed high crude oil prices as transient.

REITs remain on a SELL signal. Higher interest rates and high valuations are beginning to take their toll on this area. Given the tremendous multi-year run in REITs, the downside is easily in the double-digits.

Higher highs and higher lows is how you define a bull market. The intermediate-term trend is still upward. Near-term, the USD could consolidate gains. The USD remains on a BUY and we are long.

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