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July 3, 2001

July 3, 2001

Here we are July 3 and I am writing to share our opinions and outlook for the coming weeks.

For the first six months of 2001, we have seen the market transitioning from a declining market in the first quarter to a bottoming market in the second quarter. The S&P 500 is down 7.3% and the Nasdaq Composite is down 12.6% on the year.

THE ECONOMY

Economic activity is still slowing worldwide as the technology bubble of 1998-1999 and early 2000 is being deflated. Over-ordering for Y2K and double ordering by customers who were expecting shortages have led to a classic global inventory correction in telecom and technology sectors. This is causing a technology-led recession to be felt in the U.S., Japan and much of Asia. Eventually this technology-led recession will be felt in Europe as well.

We are seeing positive forces begin to exert themselves and the economy should benefit from them. Since the beginning of the year, the U.S. Federal Reserve has lowered interest rates five times. Monetary easing in the U.S. is being supplemented by easier money in Japan and to a lesser degree, in Europe. After the technology-led inventory correction partially runs its course, this monetary accommodation will eventually lead to a strengthening in demand and stronger economic growth. In addition, energy prices have been moderating from the levels seen earlier this year. This should also help the recovery in consumer demand and corporate profits.

U.S. MARKET OUTLOOK

Overall, we are positive on the market which we believe has bottomed. It is only a matter of time until the broad market begins to rise. Thus far, the market’s recovery has been focused in the mid to smaller capitalization companies with lower P/E’s. These stocks are inexpensive and were under-owned by portfolio managers during the technology bubble of the late ’90’s.

In the second quarter, we began to purchase a number of small and mid-cap companies with strong growth rates and low valuations. We believe that many of these smaller companies that have grown steadily will continue to grow. They will become recognized by the market and their values will expand faster than their growth rate. This is where we are focusing our research. We do not believe the leaders of the past bull market, the large cap tech stocks, will lead in the future. Historically, the leaders of one bull market become the leaders of the next market cycle only about 5% of the time.

FOREIGN MARKETS

In general, we believe that foreign markets offer fewer opportunities at this time. Economic slowing in the U.S., Japan and Asia will be followed by a slowing in Europe. Some exceptions might be Ireland which is regarded as being the most “business-friendly” member in the EU and perhaps Canada which is rich in energy and resources. Thus far in 2001, foreign markets have generally under performed the U.S. We expect more opportunities to arise in late 2001 or early 2002 as global economic growth picks up.

CURRENCIES

The continuing strength in the U.S. dollar does not surprise us. Japan is still in a serious economic mess and Europe appears to be reverting to antiquated socialist programs under the “New Europe”. We expect the yen and Euro to rally in July and perhaps for the remaining summer months, but by autumn they should be declining again since the macro-economic fundamentals for the U.S. dollar are better.

SUMMARY

The U.S. market is currently the world’s most attractive. Since early April it has been rising in a gradual, albeit, sporadic manner. Large capitalization stocks and high-technology stocks are down on the year and in some cases are still declining, whereas many small and medium sized low P/E growth companies are up in 2001. We are continuing (as we mentioned in the last two letters) to focus our research on these types of companies. The industries we are researching include business services, education, medical technology, cosmetics, engineering services, energy and consumer services.

Our research has brought to our attention a solid group of steadily growing prospective companies that we believe will outperform. We plan to gradually accumulate them when their prices reach attractive levels. Our extensive experience in the markets has taught us that thorough research and disciplined investing are the keys to long-term investment success.

We hope you are having a pleasant summer season.