FPA Capital Fund's Semi-Annual Report

In light of the above comments, we believe the odds of a 2008 recession have increased to at least 50%, or more. Given the growing credit contraction, oil prices approaching $90 per barrel and the dollar setting new alltime lows versus a basket of currencies; future Fed policy actions may prove rather ineffectual in dealing with these challenges. We are of the opinion that the Fed will lower the Fed Funds rate into the 3.75% to 4% range next year, or lower, as housing, capital markets and consumer issues negatively affect economic and corporate earnings growth. We view consensus earnings growth expectations as being too high and believe that they will have to be lowered. Only recently have various types of financial services companies begun to recognize their problem loans and investments, with charges and provisions for future losses. Some of these stocks have responded favorably, with the belief that these companies are getting their problems behind them. Again, we believe the consensus is being too optimistic. Generally, managements are always initially optimistic, until they have to face the grim reality of the situation, and this process should extend well into 2008. The stock market appears to be ignoring these various risks since there appears to be a general belief that lower interest rates will ride to the rescue to solve these credit problems and support stock prices. We do not agree with this optimistic view and, therefore, we will continue to deploy a highly defensive portfolio strategy since we do not believe we are being appropriately compensated for these risks.