Client Letter - 11/20/03

November 20, 2003

To Our Investors and Friends:

The markets have moved up this year for two reasons: First, we had a euphoric war rally, which started in the weeks just before we invaded Iraq; and, second, we have had the beginning of an economic recovery, which is at least partially related to next year’s presidential election. Year-to-date, the S&P 500 Index is up approximately 17.5%, a little more than half-way to recovering the losses it incurred last year (a loss of 23.4% in 2003 requires a gain of 30.5% to break-even).

It is conventional wisdom that, somehow, a war is good for the stock market, perhaps because it replaces the anxiety of anticipation with greater certainty and direction. It also represents the “vortex” of the so-called high risk/reward scenario. In the early going, at least, the war went “as planned”, and the market rise seemed justified. We had been very conservative in the year leading up to the war, successfully protecting client capital from the worst year so far in the secular bear market. Our decision was to not take the high-risk/reward proposition, and instead wait for a more comfortable entry point. Given our focus on long-term performance, we considered it worth the risk of missing a “war rally”. As it turns out, much of this rally continues to ride on high-beta (i.e. high-risk) equities, while many of the stocks we follow (lower beta, value-creating companies) have been left behind and still present potentially good opportunities.

After enduring a summer of rather downbeat economic news, the market has continued higher in hopes of a late 2003 recovery, which is what we are seeing, despite a lack of strong jobs growth. Investors have poured money into cyclical stocks, those that benefit from the early stages of economic growth. Many of these have reached levels well above fair value. Because much of this economic recovery is the result of a huge fiscal stimulus, which along with Iraq is contributing to significant deficit spending, there is reason to believe that the recovery may not be sustainable in the longer term, particularly as inflation resurfaces and interest rates rise. For the moment, however, with an election year ahead of us, it is likely that the Federal Reserve and the White House can keep the recovery alive and possibly even re-create some of the several million jobs that have been lost. This has given us a real opportunity to begin reinvesting cash that has been kept in safekeeping.

Our portfolio opportunities are focused generally on protective stocks that generate high value creation and good dividends, and which are seemingly out of favor at the moment. Examples include General Mills, General Electric, ConAgra, Johnson & Johnson, and TCF Financial. We are also seeking good valuation in proven growth companies such as Medtronic and UnitedHealth Group. We will not rush to invest cash in hopes of catching up with this year’s “beta-chasing” or “cyclical” rallies. None of our holdings will deviate from our strategy of investing in companies with consistently good returns on capital and reasonable valuations.

We continue to be very careful about what we do. As we return to greater normalcy (and we do hope that’s the case) we will see, at various times, the market declining, rallying, and rotating among sectors. However, given the mix of economic uncertainty, the obvious threats of global terrorism, and the high level of stock market speculation, the significant volatility of the past several years is likely to continue. We have endured the early stages of this secular bear market through capital preservation. That is the single most important element to outperforming the market in the long term. There will be more rallies and sector rotations to come, and we will look to our investment discipline to guide us.

Best wishes for a good holiday season,