1. The world is currently seeing pressure in all areas. We see evidence of this every day, even from more basic areas of the market

such as coffee retailer Starbucks, which recently announced the closure of 600 outlets. Stagflation is becoming more evident in

the global economy and we expect this to be a phenomenon that will prevail over the next few years. Monetary authorities are

torn between hiking up interest rates to double-digits in order to control inflation, and reducing interest rates further (although

the U.S. Fed has little room to maneuver) in order to encourage economic growth. It has been reported that a quarter of the

world is experiencing double-digit inflation.

2. Ben Bernanke is faced with the same problem that Alan Greenspan faced in the early 1990’s in that there is no playbook that one

can follow to determine the right course of action. Greenspan lowered short rates and allowed the banks to earn their way back

to profitability via the steep yield curve, borrowing short and lending long, reducing the taxpayer burden. Now, Bernanke faces

the difficult decision of whether to raise short term interest rates. This move could quell inflation, stabilize the dollar, and

reduce long term interest rates, but also push the economy into a deep recession. Otherwise, he could leave short term rates

low and risk slowing the stabilization in housing prices due to potentially rising inflation, leading to higher longer term interest

rates and a falling dollar.

3. Inflation is also becoming a huge problem in the emerging market economies. At some point, policy-makers in pegged or

managed currency regimes may find that the benefit of stronger export growth no longer trumps the need for contained inflation.

If this were to occur on a large-scale, global currency volatility would increase dramatically.

4. According to many pundits, stocks look cheaper than last quarter, but they also discount a rise in the risk free rate and risk

premia, together with a downgrade in the level of forecast earnings for next year and the following year. We made this point in

our last quarterly letter, and stand by this view. PE ratios and Discounted Cash Flow ratios need to be adjusted for higher risk

premia and lower earnings. In addition, higher inflation expectations and volatility, tend to command lower PE multiples.

Forecast earnings remain very high and we believe the market has been falling because investors are already discounting in the

fact that the lofty earnings expectations will not be met in the second half of the year.

5. Write-downs by banks and other financial institutions are clearly not over yet. The IMF estimates that total write-downs will

amount to $1 trillion globally. The balance sheet repair process will take time in the West. Meanwhile, Japanese banks have

come through the crisis relatively unscathed so far, and are stocking up for spending sprees comparable to the Sovereign Wealth

Funds.

6. According to the McKinsey Global Institute, Asian Sovereign Wealth funds are reported to have amassed $670 billion, while their

governments hold $3.9 trillion in FX reserves. Similarly, oil exporting nations have amassed financial assets of $4.6 trillion. As a

comparative, private equity assets are around $900 billion, hedge fund assets $1.9 trillion, and the market capitalization of the