Third Quarter, 2002

Anecdotal stories abound of investors (not our clients, mind you, but those of other advisors, brokers, or financial planners) no longer opening their quarterly statements out of a desire not to become depressed over the continued shrinkage of their portfolio values.

Having already made it to the second paragraph of this report, you are to be commended for boldness and bravery, especially in the face of a withering barrage of bad economic and investment news. Our client portfolios fared considerably better than the stock markets alone because we continue to minimize the proportion of client assets dedicated to stocks.

This bear market for stocks, now in its third calendar year, ranks second only to the Depression years of 1929-32 in its severity. Unfortunately, the prior excesses of the 1990s have not been completely dissipated throughout either the economy or the financial markets at this time. In fact, based upon the past hundred years of stock market history, today’s valuation indicators are at levels normally indicative of bull market peaks, not bear market lows.

The economic recovery continues to ride on the backs of consumers. Now, mounting evidence reveals that consumers have become increasingly over-leveraged and financially tapped out. The combination of high levels of consumer debt and growing deflationary trends has particularly ominous overtones for future consumer spending.

Today, safety and cash flow are the primary investment criteria we consider when making adjustments to client portfolios. We have reduced stock holdings to levels at the low end of our agreed-upon policy guidelines. When we acquire bonds for client portfolios, they are typically the highest grade corporate bonds or U.S. Treasury securities. However, we still seek out attractive convertible bonds that may be of somewhat lower financial strength. Finally, one of the conservative strategies we are currently using to boost cash flow into portfolios is writing covered call options.

As of this date, the overall stock market is dramatically oversold and is due for a technical rally. Market technicians make an analogy to a spring which becomes coiled tighter and tighter. The tighter the coiling, the more violent the bounce when the pressure is relieved. The stock market is overdue for such a bounce. Trying to time such a rally is exceptionally difficult, for whenever a rally has begun during the past two months, it is quickly overwhelmed by massive waves of stock selling by large financial institutions seeking to reduce their market exposure. This market action is another sign that the bottom may be a long way off.

Our strategy as we move into the fourth quarter continues to incorporate the following features:
      1. Maintain stock market exposure at the low end of our agreed-upon range; 
      2. Focus on higher dividend-yielding securities to increase portfolio cash flow; and
      3. Avoid higher leveraged securities which tend to perform poorly in a deflationary environment.