PERFORMANCE ANNOUNCEMENT

As Of: April 26, 2006

TIME FOR A CORRECTION?

The wall of worry is growing higher.

    Inspite of rising oil prices, rising interest rates, and a whole host of geopolitical worries, the consumer is still consuming and the economy is still growing. The stock market has climbed the proverbial "wall of worry" and posted gains. But beneath the indexes, there hides a very lumpy distribution of performance in the market. This has not been the traditional case of a rising tide lifting all boats.

    Historically, a ten percent correction in the stock market is a very regular event, occurring every year or two. Investors have a difficult dilemma to contemplate. The Standard & Poor's 500 index has not had a ten percent correction since its low in October of 2002. After 42 months, we are overdue! To make matters worse, the market has only gone up ten percent in the last two years. Thus, if the market does experience a normal a ten percent correction, the last two years will have counted for nothing. But that is not the worst part of the story. A ten percent correction that takes us back to the level of two years ago, also takes us back to the level of July, 1998. For a "buy and hold" investor, a ten percent correction can wipe out the last eight years of time in the stock market. This should provoke some thought about how one approaches risk management. While most investors tend to focus on beating the averages, a more important discipline over the last decade has been to protect gains and avoid losses.

    One way to protect portfolio gains is to emphasize the collection of dividends and interest. Protecting capital gains is a more complex problem. If capital gains are booked by selling the position, then taxes become collateral damage (except in tax sheltered accounts). Alternatively, capital gains can be protected by hedging through short selling and the use of options and futures; but this kind of insurance also has a cost. There is no free lunch. There is no risk free return in the stock market. But judgement and discipline regarding when and how to manage risk are important ingredients for superior long term performance. This is a period of time when beating the market is perhaps not as important as protecting one's capital, particularly in light of the knowledge that, statistically, the second half of this year is the worst performing period in the four year presidential cycle.