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Fourth Quarter 2007

The fourth quarter of 2007 was characterized by a worsening of the subprime mortgage crisis, which has caused some major disruptions to the credit and financial markets, resulting in a contraction of the availability of credit worldwide. This, coupled with a greater than expected housing recession in the U.S., is likely to result in a slowdown of both domestic and international growth in 2008. The U.S. housing downturn is deeper than anticipated, likely to continue, and its after effects will be felt into 2009 as ARM resets continue to pressure mortgage holders. Surprisingly, retail sales volumes have held up quite well, but conditions now suggest that consumer spending will be impacted next year.

The sectors hit hardest by these two crises were financials and real estate. The outlook for them remains uncertain in the near term, especially in the case of the financial sector. Interbank lending rates remain high and it remains to be seen how long it will take them to normalize. When they do, there may be some good investment opportunities in the financial sector. However, the effects of the subprime mortgage crisis on bank balance sheets may overhang well into 2008. Mortgage foreclosures also may accelerate in 2008 and 2009 as more than 2.5 million subprime mortgages reset to levels considerably higher than their “starter” rate. Many of these borrowers have little equity in their homes.

Against this backdrop of tighter credit and weakening growth, housing prices are likely to continue falling throughout 2008 and consumption will weaken. Despite inflationary pressures from higher commodity prices, inflation should now remain moderate because some 40% of U.S. inflation comes from the housing sector. This will permit the Federal Reserve to continue cutting interest rates aggressively throughout 2008, as well as the Bank of England and the European Central Bank.

While Brent crude oil approached $95 per barrel, the dollar hit new lows against other major currencies, and gold hit new highs. The low level of the dollar today will help U.S exporters, which will prove to be a bright spot for the U.S economy going forward. Geopolitical risks will continue to increase in 2008, accompanied by a new awareness and aversion to risk by global investors. Although we believe that a recession is still unlikely, we exercise caution in our stock market outlook and would not be surprised to see a continuation of a pullback in equity prices in the first quarter of 2008.

For the year, the Dow gained 6.4%, The S&P 500 rose 3.5%, and the Nasdaq was up 9.8%.
Grant Rogers Elizabeth Allen

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This report has been prepared by Metis Capital Management LLC. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst responsible for the preparation of this report may interact with trading desk personnel, sales personnel, other analysts, journalists, and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Metis Capital Management LLC is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Metis Capital Management LLC accepts no liability for any loss or damage arising out of the use of all or any part of this report.

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