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Third Quarter 2008 Quarterly Newsletter

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They Shoot Horses Don't They?

Despite the fact that global Capitalism is more prevalent today then ever before, it does have its
drawbacks. For starters, it doesn't have empathy. It doesn't feel sorry for those negatively affected
by it. You're in a recession? Tough! Your company's gone bankrupt? Big deal! Can't feed your
kids? Not its problem! Capitalism is similar to the law of the jungle -- survival of the fittest. When
supply and demand line up against each other, Capitalism really doesn't care who wins. The weak
become dust, and the strong continue onward until a future time when they may also hit the
ground. With Capitalism, it's all in a day's work, and there are no emotional repercussions
regardless of the outcome.

With humans, it's a different story. We simply aren't fond of economic hardships, or losing our jobs,
or not providing for our families. Consequently, we empower our government to attempt to tweak
Capitalism so that we can thrive from its benefits, but buffer ourselves from its adversities. That's
the reason for the Securities Acts of 1933 and 1934, ongoing actions by the Federal Reserve and
US Treasury, and the myriad layers of state and federal laws and regulations promulgated over the
last 75 years.

The recent federal $700 Billion bailout is an example of our government doing its darnedest to
prevent as much human misery as possible. Some extreme pundits have labeled it "The End of
Capitalism," because of the great lengths the government has taken to prevent those jungle losers
from becoming dust. Those questioning the government's actions do not feel taxpayers should be
propping up inferior companies nor helping greedy executives stay employed. After all, they reason,
they shoot horses when they can no longer function -- should it be any different when a company
can no longer survive on its own?

In our view, there is a big difference. The government bailout of financial institutions and its
guarantee of money market funds were not simply to save poorly run companies and their execs.
Rather, it was an attempt to prevent a firestorm of spiraling economic upheaval that would negatively
affect all in its path, with the potential to hurt the little guys on Main Street even harder than the
bigwigs on Wall Street.

It took mistakes by all parties to get this real estate/sub prime mortgage/credit crunch-debacle to its
current status. Yes, financing companies were greedy by extending mortgages to unsound owners.
And Wall Street banks and brokers tried to leverage the resulting multi-layered/collateralized debt to
the hilt. But doesn't the lack of government oversight also point to errors from that side of the
equation? And lastly, those homeowners and speculative landlords initially requesting the risky
mortgages didn't have guns at their heads. They apparently believed that real estate prices would
increase forever and/or interest rates would stay historically low as well. In effect, all parties share in
the blame.

Perhaps the ugliest part of the federal bailout was the grotesque political partisanship underbelly that
was so blatantly exposed during the process. Certain Congressional members outwardly admitting
that the reason they didn't vote for the failed first bill was because their feathers were ruffled by a
speech by the House Majority Leader. How's that for putting their constituency first? Even worse
was the blatant pandering and pork barrel spending used in the second (passed) bill for the sole
purpose of luring the votes needed. It clearly was a low point in our legislature's history, and an
example of what is seriously wrong with our current political culture.

Patience Is a Virtue

During bear markets, we consistently advise clients to be patient and disciplined, and wait out the
downturns. This is not easy to do, and we also know that sometimes you may get a bit tired of
hearing this advice. The chart below is the reason behind it. It shows what happens to stocks (the
S&P 500) after hitting market lows during an economic downturn.

As you can see, after a weak economy, the markets consistently improved, and quickly. More
importantly, nobody signals when it starts, and often it occurs with the worst of the economic news
still to come. This is the reason we often repeat that you must be in the market on the last day of the
bear market in order to get the full benefit of the first day (and week, month, quarter and year) of the
new bull market.

Third Quarter 2008 Asset Class Returns

The third quarter was the worst performing quarter since the early 2000's. Up until mid-September,
several domestic asset classes had positive returns. But after Lehman's demise, Merrill Lynch's
takeover by Bank of America and AIG being "rescued" by the Feds, the financial industry quickly
began to unravel. In addition, a large money market fund announced that its value was less than
$1.00 per share. Within hours, the US Treasury and Federal Reserve developed a plan to use at
least $700 Billion to buy back the "toxic" mortgages on the books of numerous banks and investment
houses, as well as guarantee money market funds that had stable value as of September 19th.
After much political posturing, this bailout plan was passed on October 3rd, and as of this writing,
foreign markets are going through their own bloodletting, which in turn is flowing over into US

Interestingly, there were some positive asset class returns for the quarter. Both Real Estate and
Micro Cap stocks were in the black for the quarter. Without question, all international asset classes'
percentages were down from mid-teen to mid-twenties. Much of that underperformance was due to a
strengthening dollar, which weighed heavily on foreign stocks denominated in non-US dollar
currencies. Lastly, with the exception of US Treasury bonds, intermediate and long term fixed
income also lost value for the quarter.

When will we hit a bottom? Clearly, the current volatility shows that the bottom could occur at any
time. However, most bottoms are recognized only in retrospect, after several months have passed
and dramatic market gains have already occurred.

Remember the following:

• When there is major panic selling in the market, it is typically in the last stages of its
• There is more than $4 Trillion in domestic money market funds and several times that in US
   Treasury Bills, much of which is earmarked for stocks when this correction is done. These
   funds will act as fuel to propel the stock market for years once the bear market is over.
• Stock valuations are cheaper today than at any time in the last few decades. Rational minds
   buy, not sell, when prices are cheap.
• Large Cap domestic stocks, exemplified by the S&P 500, have had a below average 10 year
   performance period. Historically these periods have been followed by times of dramatic out-
• The time when the market is at its cheapest is the time for the best prospective market
   performance; it is also the time of most fear in the market cycle.

As always, your Quarterly Performance Report accompanies this letter. If we have managed your
portfolio for less than three months, you will receive a partial report, and a complete one will follow
next quarter.

We will continue to keep you up to date with the use of email updates. If you have not yet received
these updates but would like to, please contact your advisor. Also, please feel free to call us
whenever you have a particular question or concern.


Frederick F. Kramer IV, JD
Chief Investment Officer