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September 30, 1999

September 30, 1999

ECONOMICS
The global economy is improving, led by Asia. Japan is coming out of its long recessionary period and has had good economic growth for the last two quarters. Developing Asia is also growing nicely, recovering from 1998’s problems in Southeast Asia. China continues to do well and those who have been predicting a devaluation of the Chinese currency are again being proven wrong. North American and European economic growth is good and corporate profits world-wide are expanding.

MARKETS
All of the above economic trends and the rise in corporate profits would be salutary for U.S. and foreign stocks especially if they were to exist in a vacuum. Unfortunately, for U.S. and European stocks, interest rates are rising in these two regions. Higher interest rates mean that debt instruments become more competitive with stocks, which sends stocks’ price to earnings (p/e) ratios down. As a result, two out of three U.S. stocks are down in 1999, while the stocks of fast growing companies in certain technology areas are still rising. For example, after years of good appreciation and steady profits, most pharmaceuticals and consumer stocks are down in 1999. This is because, although growth is steady, it is not spectacular (perhaps 10-15% per year) and a decline in p/e ratios sends these slower growing stocks down. On the other hand, many fast growing software, hardware, telecom equipment and business services stocks which grow 20 to 30%, or more, per annum have continued to hold up as investors are slower to sell their companies with higher growth rates. Should interest rates continue to ascend, eventually, the p/e ratios of these companies will also decline.

INVESTOR PSYCHOLOGY
Recent events have caused many of the highflying internet and consumer related finance companies to falter, because internet companies, in general, have no earnings and many are running low on cash. Thus, the valuations of most have declined. The biggest and best companies have lost up to one-third of their value, and the lesser quality companies have lost up to 70%. Many speculators who, in the past, would initially buy any .com company are now starting to understand that while the Internet provides great long-term opportunities for economic growth, many companies in the internet area are trying for the brass ring. Some will grasp it, most will not.

As some investors have lost money on internet stocks, speculation has lessened and more emphasis on fundamental valuations has been engendered.

Another important element of investor psychology is Y2K. Many individuals that we speak to (perhaps 20%) are concerned about Y2K. We do not believe that Y2K will have a meaningful impact on the U.S. economy or on U.S. corporate profits. Third world economies and the former Soviet economies could be in danger from Y2K, but the U.S. , Western Europe and developed Asia are not, in our opinion.

However, investor psychology may cause a decline in U.S. and foreign markets if individuals remove money from markets in November and wait until January to reinvest. We believe one should be fully invested by late December 1999 as getting in, if Y2K proves to be a non-event, will by much more be expensive on January 2 than it was on December 30.

OUR CURRENT VIEW
The U.S. market is two-tiered; fast growing stocks sell at very high valuations while the broad market has many pockets of under valuation. Within the U.S., we favor high technology leaders who supply hardware and software to the Internet or telecommunications industries, and unique quality companies with strong growth that are currently undervalued in the fields of entertainment/cable TV, pharmaceuticals and retail.

Japan is generally undervalued. After a nine year bear market the economy is undergoing a transformation as major companies like Sony, Fujitsu, Hitachi, Nippon Telephone & Telegraph and others lead a move into Internet based technology and business practices. Other developed Asian economies like Taiwan and Korea also appear attractive.

Finally, we are holding cash. Last year the market bottomed in October 9. Because we were holding cash we had an opportunity to buy stocks near their low prices. This year, we also are holding cash so that we can buy stocks at inexpensive levels should any market decline greet us in the traditionally difficult October time frame.

SUMMARY
We believe that 1999 has presented a turning point for Japan, Korea and Taiwan which may have moved into bull markets of lasting duration. The U.S. market remains positive, but one must carefully select those companies where strong growth can be maintained even in an environment of rising interest rates.

Warm regards and best wishes for a happy and healthy fall season. Please call if you would like clarification or have any questions or suggestions.