PERFORMANCE ANNOUNCEMENT

As Of: February 16, 2005

Low Probability, High Impact

A time to expect the unexpected.

    This year may be the year of the "low probability, high impact" event. Unfortunately, by its very nature, we cannot know what, or when, or even if it will happen. There are a number of events that are generally considered quite remote in their likelihood, but if they occurred they would have significant market moving power.

    Of course, unexpected events can occur anytime. During periods of stability, we do not tend to worry about the unexpected. But right now, we seem to be deprived of stability, at least psychologically. The mood that characterizes this year's markets is the expectation of the unexpected. That mood appears to be contributing to volatility and a lack of commitment by investors. The price of oil is an excellent example. On a regular basis, rumors sweep through the markets about unrest in Nigeria, government policies in Venezuela, pipeline explosions in Iraq, or a change in policy from OPEC; but oil supply has been able to consistently satisfy demand. Without an atmosphere of fear, the price of oil could be ten dollars less per barrel of oil (or more). Thus, anticipation of fearful events is having an impact on prices even in the absence (so far) of any actual event.

    The same can be said of the bond market. For more than a year, a long laundry list of possible negative jolts to the economy has been postulated if interest rates were to move up sharply. Yet, in spite of the deliberate rise in short term rates engineered by the Federal Reserve, long term rates have not gone up, and there has been no negative effect (so far).

    The fact that I have to keep adding the qualifier (so far) to my commentary is a symptom of the attitude that we don't know what or when, but the boogeyman is out there somewhere, just waiting to grab us when we least expect it. So how does an investor cope with this kind of environment? The answer is to cope intelligently, not emotionally. As mentioned before, an unexpected event can happen anytime. There is nothing special about the current environment that should make you behave differently than when all is well with the world. Basic investment discipline, including risk management and diversification, should always be applied. The risk of an unexpected market moving event is no different than an automobile accident. You cannot just wear your seatbelt when you expect to get into an accident. You cannot know when you will have an accident; thus you need to wear your seatbelt all the time.

    It is interesting to speculate what the next big thing might be; but in the absence of factual information, it is only speculation. However, volatility can present opportunities. Most often, when market prices get skewed due to a rumor or fear, they tend to return to their prevailing trend. This fact can present purchase and sale opportunities. Otherwise, it should be business as usual, with risk management uppermost on your mind.