Past 
            Commentaries
            
          
          Current Commentary, 
            Review and Outlook
            January 9th, 2002
            
          To 
          My Clients, Friends & Observers:
           
          All 
            is waste and worthless, till
            Arrives 
            the wise selecting will,
            And, 
            out of slime and chaos, Wit,
            Draws 
            the threads of fair and fit.
          It’s over, 
            investors of 2001. We’ve graduated, under budget and on time. 
            We called the bottom on September 29 and immediately discounted the 
            recovery of ’02. We did more trading (buying) in the ensuing 
            three weeks than we did in the prior five months combined. 
          On the equity 
            side we screened about a hundred companies not already in our composite, 
            passed twelve, and positioned four – all midcaps, low P/E’s, 
            strong earnings, significant dividends. We repositioned many equities 
            in our composite at fairly discounted prices. Our equity theme emphasizes 
            total return, capital appreciation and dividend growth.
          On the fixed 
            income side we have waded in from the money markets, primarily to 
            corporates, weighing portfolios to an average maturity of seven years, 
            with at least 20% of portfolios maturing in three years. Without sacrificing 
            much in yield that will protect against rising rates in longer maturities 
            from a falling dollar, ebullient money supply, fiscal and monetary 
            stimulus, and potentially rising oil prices. We want cash flow.
          Rest 
            In Peace, 1981 - 2001
          I did not foresee 
            a year ago that a Fed which had so mercilessly raised rates would 
            atone with eleven consecutive cuts. There is only a 50% chance of 
            another Fed rate cut in January but nil probability of any rate increases 
            this year. The great bull market in bonds is exhausted. Herewith our 
            obituary. It was conceived during the Carter administration, under 
            the Fed Chairmanship of G. William Miller, whose Board started to 
            take seriously the ideas of Milton Friedman (and others) to control 
            money supply and the velocity of money to control inflation. It was 
            born in 1981 during the Reagan administration, Paul Volcker presiding 
            at the Fed. Volcker’s Board refined policy further to emphasize 
            the goal of price stability. That’s continued to date under 
            Alan Greenspan. Of all the social, political and scientific ferment 
            the last twenty years the economic liberation was Prometheus unchained. 
            More people than ever before became "Free to Choose" (a book by Milton 
            and Rose Friedman). The human condition is improved because we have 
            learned and acted accordingly –a shining example of good public 
            administration.
          Michael Milken 
            -like him or not, a genius -created junk bonds and leveraged companies 
            that refinanced with equity. Over at Salomon Brothers two other geniuses, 
            Bill Simon and Louis Ranieri, were creating a mortgage backed securities 
            market that seeded whole crops of new financial instruments. Shell-shocked 
            by the prior 10 years of economic wreckage, who could have predicted 
            that the creative chaos underway in the ‘80’s would lead 
            to unemployment of 3.9%, budget surpluses, Dow 10,000, interest rates 
            of 1.75% and more concern over deflation than inflation? The invisible 
            hand was made visible, electronically and instantaneously. The financial 
            globe was an unstaked gold field and new prospectors rushed in relentlessly 
            with new tools. Real wealth, a better standard of living, was created. 
            One has to be grateful to be alive in this age and place and be optimistic 
            for the future. It was the bond market bull that laid the foundation 
            for recovery and the phenomenal, secular bull market in stocks. 
          That too ended, 
            in year 2000, along with the "peace dividend" in 2001, which contribution 
            cannot be underestimated. What we are left with are financial assets 
            generally overvalued relative to likely near-term growth rates. We 
            are also left with far more tools than we had 20 years ago to monitor, 
            evaluate, and control to a greater extent our economic fortunes. If 
            we use the standard definition of recession as two consecutive quarters 
            of negative GDP then this one will be ending by the time it’s 
            defined. And there is a fair probability that we won’t have 
            two consecutive negative quarters.
          Outlook
          Housing has remained 
            strong, the result of low mortgage rates and compelling demographics. 
            Ed Yardeni, chief economist for Deutsche Bank Alex Brown, makes the 
            point that Baby Boom II’s need for housing will not come from 
            the existing stock of Baby Boom I, who will live longer than any other 
            generation in history. Many commercial REITs liquidated during the 
            year however, after posting the best asset class gains the year before. 
            That suggests that the best money has already been made in that class.
          The auto industry 
            has had two extraordinary years of sales, replenishing the auto fleet, 
            but at low prices and low profits. They’re in for a rough couple 
            of years. 
          Certain tech 
            sectors will have to work out their obesity. I’m afraid that 
            we may never see many promising technologies realized. George Gilder, 
            the writer, thinker and leading technology guru complained in an op-ed 
            piece in the Wall Street Journal last August that federal government 
            policies were aborting many nascent technologies. He indicts OPEC, 
            internet taxation, arbitrary antitrust enforcement, deflationary monetary 
            policy, and plainly socialistic telecommunications regulations. With 
            the exception of deflationary money policy which the Fed has corrected 
            I would agree with him on all counts. By its policies the government 
            is pruning out all potential profitability from huge capital investments 
            and stifling the realization of complete, interactive, accessible, 
            cheap telecom and internet connectivity. Add up an average household’s 
            minimum monthly expenditures for TV @ $30 (33% commercials), cell 
            phones @ $40 (over and above regular home phone service) and Internet 
            access @ $30 (the world’s greatest free library). That’s 
            an extra $1,200 a year that wasn’t being spent a few years ago 
            going mostly to companies that are predominantly old tech in their 
            industry. The "last mile" of connectivity to the house is restrained 
            by the political clout of the old phone companies. I don’t think 
            this is what Judge Green had in mind when he split up AT&T. Those 
            household costs would be far lower and service far better if the government 
            would get out of the way.
          You can lead 
            a horse to water but you can’t make him drink. Government monetary 
            and fiscal policies can encourage or invite investor participation 
            but they can’t force it. Regulatory actions have the power to 
            destroy. There are $2.3 trillion in money market funds looking for 
            a place to work. The function of managerial finance is to identify 
            and enhance profitability, cut costs, gain share, raise prices. Looking 
            around, competition is relentless and brutal, pricing power is generally 
            weak, labor costs are rising. For a company with a 5% operating margin, 
            giving a 2% price discount requires a 67% increase in volume to recover 
            the lost profit, to stay even. Increasing productivity is essential 
            to a strong recovery and we need technology to do that.
          The most visible 
            growth in a tech sector is in storage, demand for which is growing 
            exponentially, and which simply cannot be delayed. It is too essential.
          OPEC has got 
            to go. The compounds that can be derived from oil are so vast in number 
            and scope that it is a tragedy that we waste it by burning it into 
            the atmosphere. Why do we risk American lives for it? Gasoline could 
            be replaced. The markets will do the rest in controlling crude oil 
            prices. The Germans have had a fleet of BMWs successfully beta testing 
            in LA for three years now burning hydrogen. Hydrocarbon emissions: 
            zero. It would take a Kennedy-esque national declaration of independence 
            from foreign oil by the end of the decade. It is an ambition worthy 
            of America. 
          Notes
          Industrial capacity 
            utilization fell to 74.7% in November. The NAPM Price Index fell to 
            34.7 in December, down from its peak of 78.5 in March 2000.
          Money supply 
            through November ’01 increased year to year 6.5% for M1, 10.5% 
            for M2, 14% for M3, and was accelerating the last three months. Clearly 
            inflationary and that’s OK.
          Oil closed the 
            year at $19.84. Gold at $278.70. Commodities, basic materials, in 
            the DJ-AIG Commodity Index closed at 89 (1991 = 100). This index appears 
            to have bottomed and bears scrutiny. Nominal inflation in November 
            was 1.9%.
          Communist China 
            enhanced its version of Social Security by giving participants some 
            discretionary investment authority. Russia completely replaced its 
            regressive, unwieldy, complicated tax system with a simplified flat 
            tax resulting in a boom of compliance and revenues. The Russian economy 
            is finally rebounding, strongly.
          The agency that 
            collects analysts consensus, First Call, predicts S&P 500 earnings 
            growth of 
          –22% in 
            2001 and +16% in 2002. 
          The rate of obesity 
            in American children increased 50% in the 1990’s. (MSNBC)
          Targets for 12/31/02: 
            DJIA 11,542; S&P 500 1,274; NASDAQ Composite 2594. On the yield 
            curve we forecast a 1.5% Fed Funds Rate, a 5% five year note and a 
            6.5% ten year note. Positive indicators of stable growth.
          New 
            slaves fulfilled the poet’s dream,
            Galvanic 
            wire, strong-shouldered steam.
            Then 
            docks were built, and crops were stored,
            And 
            ingots added to the hoard.
            But, 
            though light-headed man forget,
            Remembering 
            Matter pays her debt:
            Still, 
            through her motes and masses, draw
            Electric 
            thrills and ties of Law,
            Which 
            bind the strengths of Nature wild
            To 
            the conscience of a child.
          The poem is "Wealth" 
            from the book Conduct Of Life by Ralph Waldo Emerson, 1860
          Best regards,
           
          
          