We have some thoughts on what may take place in 2008, but first we want to review the major predictions and observations we made in 2007.

Looking back over the articles we wrote last year (of which there were embarrassingly few -- something we intend to change in 2008!), the major themes we discussed largely turned out to be correct.

We thought that holders of US dollar cash were subject to serious purchasing power risk. In that January 2007 article, we specifically suggested that investors hedge against purchasing power loss by placing a portion of their holdings into reasonably priced stocks (with no exposure to the mortgage crisis), international stocks, foreign bonds, precious metals, natural resources, and stocks of the producers of the latter two items.

This advice turned out to be right on. The US Dollar Index ended up declining more than 8% over the course of the year, and even the wholly inadequate CPI most recently measured year-over-year inflation at nearly 5%. It definitely turned out to be a bad year for dollar cash holders. Meanwhile, the various asset classes we recommended as a hedge all did well -- some of them exceedingly well.

We thought the US stock market was at risk due to a combination of high valuations and assorted macroeconomic headwinds. We looked kind of stupid for a while as the Dow hit 13,000 (a milestone whose celebration we dutifully mocked) and looked stupider still as it went on to hit 14,000. Eventually, though, the markets did turn down. Since the day of our first article about market risk, the S&P 500 is as I write this down 3% and the Russell 2000 is down 11% (not including dividends).

However, we only get partial credit here. The Dow is actually up since we wrote the article, by a whopping .02% before dividends, and while we did get a general downturn in 2007, it was milder than we expected. This shortcoming is discussed further below.

We thought that there would be a deleveraging and increase in risk aversion at some point, ushering in a protracted downturn in stocks with exposure to the "speculative financial economy." We point to the now-ubiquitous use of the term "credit crunch" as proof that the first part of this prediction came to pass in 2007; for the second part, we refer you to the stock chart of pretty much any mortgage lender, homebuilder, bank, or brokerage.

We thought the government would attempt to stimulate their way out of the crunch. And they wasted no time in doing so. Legislators immediately started competing to see who could propose the most outrageous bailout; meanwhile, the Fed slashed rates, ignoring serious inflationary warning signs and a plunging dollar.

But while this forecast was qualitatively correct, we weren't exactly right on the timing. We thought that the deleveraging process would lead to a slowdown, after which time the reflation efforts would begin. But the powers that be initiated a preemptive strike, beginning the reflation campaign at the first sign of trouble in the asset markets. As cynical as we thought we were, they surprised even us with their open intervention in the financial markets and their total disregard for the soundness of the US Dollar.

This, we think, is why our general stock market forecast was a little too dire. Modern monetary and fiscal reflation efforts tend not to do anything for the burst bubbles at which they are targeted; instead they tend to stimulate the already healthy sectors of the economy. (In the post dot-bomb reflation campaign, for instance, the stimulus didn't bolster capital spending as intended but instead found its way into the housing market and caused a bubble there.) We expected the credit crunch to cause a widespread selloff, but we now believe the combination a surfeit of money in the financial markets (fruits of prior reflation efforts) and a Fed and Congress that are accomodative to the point of recklessness prevented this from happening.

Other having too much faith in our leadership, and perhaps too little (short term) faith in the market sectors with good fundamentals, we ended up having a pretty good handle on what would happen in 2007. We also got some good insights into the enormous extent to which the current monetary and legislative authorities will go in their attempts to bolster economic activity and financial market stability -- something that will inform our strategies for 2008.