Client Letter - 9/11/04

September 11, 2004

To Our Investors and Friends:

Three years after 9/11, despite all that has happened since that day, the socioeconomic tone of our country is best described as uncertain; uncertain about terrorism, uncertain about politics and the election, about the war in Iraq, about the price of oil, about the dollar and, mostly, uncertain about the economic well-being of our country and world.

Since socioeconomic attitudes are what drive the stock market, it too is very uncertain. In the three years since 9/11, the S&P 500 Index has risen just two percentage points. In other words, the Index’s highly touted 26 percent gain in 2003 just barely offset its losses in 2002 and its virtually flat performance thus far in 2004. Since the market had declined significantly in the months prior to 9/11, a more realistic measure is to look at market performance since the beginning of 2001. Viewed that way, the S&P Index has lost approximately 15 percent, a deficit that requires a 17.6 percent gain to offset. In other words, a money market cash investment with a very low yield during that whole period has significantly outperformed an investment in the S&P 500 Index! These unsatisfactory results have occurred despite a significant recovery in corporate profits during the last two years, created by massive monetary and fiscal stimuli.

It’s the economy! In our view, despite terrorist threats, election year rhetoric and the war, what mostly underlies market uncertainty are macroeconomic issues. Here is a non-political description of the situation by Stephen Roach, chief economist of Morgan Stanley, dated September 3rd:

“Forget about politics -- at least for the moment -- and consider the facts: This economic recovery, by most conventional measures, has been amazingly lousy. Annualized growth in real GDP has averaged 3.4% over the first ten quarters of this upturn, far below the 5% norm of the previous six business cycles. Nonfarm payroll employment is up only 0.1%, on average, over the past ten quarters -- hugely deficient when compared with the 2.7% record of the past six recoveries. Real wage and salary disbursements -- the essence of the economy’s organic, or internal, income-generating capacity -- is up at only a 0.8% average annual rate over the past ten quarters versus the 3.9% norm of the previous six upturns. The federal government budget is out of control, having swung from surplus to deficit by six percentage points of GDP from 2000 to 2003. This was key in pushing the net national saving rate down to its all time low of 0.4% of GNP in early 2003. Lacking in domestic saving, the US has had to import foreign saving in order to keep the economy growing; that has given rise to a record current account deficit of 5.1% of GDP. All this speaks of a vulnerable and exceedingly low-quality recovery in the US.”

Considering these facts, but also keeping in mind continued growth in corporate profits, we are carefully proceeding to deploy client capital into the market. Since 2002, when we conserved a significant amount of capital in the market downturn, we have been carefully selecting conservative, value-creating (EVA) equities that we have identified as fairly valued through our intrinsic-value modeling discipline. Many of these stocks have better dividend yields than equivalent money market cash investments and, in our opinion, all provide much better opportunities than the market in general. Our present strategy is to be approximately 70 percent invested in equities, with the balance in money market cash, between now and the election. We took some profits during the summer to protect capital and will not hesitate to do so again. However, we also will not hesitate to deploy additional capital if we see the right opportunity.

We believe that our capital-conserving and carefully analyzed equity strategies have significantly benefited our investors during the challenging times of the past three years, and should continue to do so in the uncertain times ahead. As always, we will be pleased to hear from you.