7.10.20022002 Second Quarter Client Letter Faced with growing scandals and shrinking portfolios, many investors wonder how to put all this unwelcome news into reasonable perspective. Boom times provide enhanced opportunity for a small number of greedy crooks who desperately desire more of what they already have. Parallels continue to be drawn between the roaring 1920’s and the 2000’s. J.K. Galbraith described the fraud during the 1920’s: “At any given time there exists an inventory of undiscovered embezzlement in … businesses. It varies in size with the business cycle. In good times people are relaxed, trusting and money is plentiful. Under these circumstances, the rate of embezzlement grows and the rate of discovery falls off. In depressions all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous.” The financial markets were hit with terrorist bombs last fall and fraudulent bombs more recently. Last fall the market soared while the economy was contracting. Now the economy is soaring and the market is contracting. Displayed are two graphs, U.S. Weekly Leading Index (growth rate) and S&P500. The first graph depicts, in September 2001, the economy was contracting at an annual rate of -9%. Since September, the economic growth rate has soared. To attest, the first quarter 2002 gross domestic product increased 6.1%. This graph anticipates future economic expansion of 6-7%. Graph 2 illustrates the S&P500 index. From July 1, 2001 to March 15, 2002, the S&P500 has a very similar shape as the U.S. Weekly Leading Index. A dip in growth was mirrored by a dip in the S&P500 as seen in January and February. Since March 15th; however, the two graphs diverge. Growth continues to soar and the stock market continues to sell off. Fraud makes major news but is only a minor part of the economic activity. The number of incidents of fraud seam high, but in reality they are miniscule to the number of companies. The media’s focus on the exceptional cases of Enron and Worldcom is similar to its focus on a rare crash of a commercial airliner; the million safe flights a month do not merit public notice. No economy is void of fraud, but ours punishes those accused of fraud. The U.S. legal and accounting systems are designed to resolve such fraudulent acts. The economic climate is improving everyday. Are the good companies being unfairly categorized with the fraudulent companies? Contrary to last quarter, I view this market sell-off as an opportunity, not a long-term downward trend. Which graph is right? They should not move in opposite directions. If the economy slows dramatically, then these depressed stock levels may be justified. However, I continue to believe the economy will not slow dramatically for another 7 years. Until then, I view this as an opportunity.