Client Letter - 1/10/05

January 10, 2005

To Our Investors and Friends:

The performance of the stock market in 2004 may well be a preview of how we can expect markets to behave over the next several years. By long-term historical standards, the broader market represented by the S&P 500 performed well, with a return of 9%. The narrower Dow Jones Industrial Average returned only 3.5%, due largely to fallout from the pharmaceutical industry. Last year’s market factors, such as low interest rates, large deficits, a weakening dollar, higher oil prices and an emotional presidential election all contributed to tempered growth in the economy and stock market. Although these factors are certain to change, the result will most likely be modest, yet satisfactory, gains in the economy and the stock market over the next several years.

Resolving uncertainty is the largest issue when looking at future stock market returns. During the latter half of 2004, the market was given the certainty of a Federal Reserve committed to raising short-term interest rates due to signs of solid growth in the economy. In addition, a long and emotional presidential campaign came to a clear and undisputed end. In fact, the market achieved almost 80% of its 2004 return after November 2nd. The need for a weaker U.S. dollar also became clear, in the face of growing fiscal and trade deficits. This was clearly affirmed by Alan Greenspan on November 19th when he said: “International investors will eventually adjust their accumulation of dollar assets, elevating the cost of financing the U.S. current account deficit.” This realization has in fact lifted the stock market with expectations of a short-term increase in exports for U.S. manufacturing corporations. While the ongoing positive and negative impacts of these events are debatable, they allowed markets to rationalize. In the absence of terrorism inside our borders, they led to positive economic and market returns.

As we enter 2005, we can begin to see the challenges and uncertainties that lie ahead. What will be the result of the Bush fiscal policy and the towering fiscal and trade deficits? Will international investors continue to overcome the risk of a weak dollar for the safety of the “risk-free” U.S. government bond, or opt for attractive relative U.S. asset prices due to their stronger currencies? Or will a continued decline of the dollar lead to higher interest rates, slower economic growth, higher unemployment, and a weakened consumer? Our guess is that the potential growth of the economy is certainly limited by these risks, but by no means stifled. With long-term interest rates starting the year near historically low levels, and the unemployment rate at a relatively healthy 5.4%, the economy has a strong foundation to maintain stable growth into 2005. With a wary eye toward the war on terror, we feel this environment, though challenging, provides an excellent opportunity to employ our investment management discipline.

Our holdings have outperformed the market this year and we are quite comfortable being significantly deployed in stocks at this time. Our holdings, for the most part, are conservative and dividend paying. GE (our largest holding), General Mills, Kellogg, ConAgra, Johnson & Johnson and J.P. Morgan Chase are good examples. We have also made a particular effort to take positions that are likely to benefit from a weaker dollar; for example, Berkshire Hathaway, PNC Financial and U.S. Bank. As in 2004, we expect to continue taking some of the significant gains in our portfolio as the year progresses. We have several other investments that we plan to make and we expect to have cash available to be opportunistic when the time is right.

As always, we enjoy your questions and comments. Happy New Year!