QUARTERLY COMMENTARY SECOND QUARTER 2004

THE MARKETS
During the second quarter stocks traded sideways and bonds shifted down. Equity and bond prices reacted to concerns of rising interest rates as the March Jobs report significantly surpassed consensus expectations, demonstrating the economys strength and heightening fears that an increase in the Fed Funds rate by the Federal Reserve Open Market Committee (FOMC) might be imminent. Mixed earnings forecasts, energy prices, fears of terrorism and the politics of an election year weighed on the stock market, causing it to trade sideways with trend-less volatility. (Please see the table below for quarterly and year to date performance data.) Reversing a trend that started in the spring of Index Performance 2003, large cap stocks DowJones Industrials such as those in the Dow S&P 500 or S&P, performed better than small stocks EAFE and foreign markets in Russell 2000 the 2nd Quarter of 2004. Lehman Intermediate The U.S. stock market Lehman Municipal was mixed during the quarter with the oil sector and big market names like General Electric, Proctor and Gamble and PepsiCo up while the technology and pharmaceutical sectors were down. Late in the quarter the stocks of retail companies were weak reflecting the fear that higher interest rates will lead to slower sales growth. with the words: At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Few sentences have been as analyzed or editorialized as much as this one. On June 29th the FOMC took the first step to increase interest rates by raising the Fed Funds rate target from 1.00% to 1.25%. (See the chart on the next page.) This is indeed a measured response to the significant increases weve seen in the prices of raw material commodities such as crude oil, steel and other industrial metals. At this stage, 30 months into an economic recovery, we would expect a real rate of interest of 2nd Qtr over 1.00%. With the 2004 YTD CPI at 2.50% this 1.24% 0.80% implies that the Fed 1.71% 3.43% Funds rate needs to rise 0.43% 4.88% above 3.50%. We 0.49% 6.78% anticipate short-term -2.44% -0.11% rates will increase much -2.37% -0.63% further.

THE ECONOMY
Business spending is accelerating. The most recent Institute for Supply Management survey confirmed production, new orders, employment, and backlog are all growing. Inventories are reported to be unsustainably low therefore the trend of improvement in the ISM data is expected to continue. In December 2000 Carly Fiorina, the CEO of Hewlett Packard, declared that business had turned out the lights. Is she perhaps ready to declare that they have been turned back on? With the resurgence of the U.S. economy clearly in evidence, the Euro, which hit a high to the U.S. Dollar of $1.28/ in January, sank to $1.18/ in April and ended the quarter at $1.22/. We anticipate further Dollar strength as U.S. interest rates rise and attract foreign capital. The Chinese

FEDERAL RESERVE
Most significantly, in May, Alan Greenspan was nominated for a 5th term as chairman of the Fed. His full 14-year term as a member of the Federal Reserve Board of Governors will end on January 31, 2006 at which time he will retire. The legacy of his tenure will be to have successfully steered us through the 87 crash and the Internet boom and bust. In early May the FOMC, headed by Chairman Greenspan, formally announced their bias change

authorities have begun the process to slow their overheated economy. Speculation on whether Chinas economy will have a hard or a soft landing has caused ripples throughout the international markets. Fueled partially by the strength of economic growth in China, the world markets have experienced economic expansion. At this juncture it looks as though the U.S. is again becoming the primary engine of worldwide economic growth.

recent releases of Former President Clintons My Life and Michael Moores Fahrenheit 911. The former is negative for the Democrats and the latter for the Republicans, in exposing old wounds or creating new ones. The parties spending is going to be focused on the few swing states such as Florida, Pennsylvania, Ohio, and Michigan etc. California is assumed to be going to the Democrats

Target Fed Funds Rate

7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

EXPECTATIONS
Looking forward, this summer promises to be one where uncertainty prevails. Politics will take center stage from the trend-less markets. We all fear a Madrid style terrorist strike in the run-up to November elections, and the summers political conventions are taking precautions by spending significantly on security. The Presidential election will be close, negative and polarized. As always with an incumbent, the election will be focused on whether to rehire George W. Bush. Over the last year President Bushs prospects have been fading. Abu Ghraib, the justification for the Iraq war and the management of its outcome are hurting his re-election prospects. The election fires have been stoked with the entertainment industrys and will see little attention from either party in 2004. Ronald Regans recent passing has reminded us of his legacy: How the fall of Communism and the reunification of Germany resulted in a significant increase in worldwide consumers and set the stage for the booming economic 1990s. Will either of our current candidates be capable of such distinction? History will be the judge but the markets current anticipatory behavior is not encouraging.

THE FIRM
Our firm continues to grow. Assets under our management now exceed $160 million. In June, Katie Altneu joined us as our Trader and Research Assistant. Please join us in welcoming Katie and let her know how she can be of service when you call.