Investment Perspectives Update -- August, 2007

Dear Investor,

Our portfolios took a bit of a hit last month, so I thought I'd share a few thoughts.

The stock market has weakened lately because of what's known as a "credit crunch". This is a situation where credit becomes either very expensive or impossible to obtain. It was triggered by weakness in housing prices which led to defaults in the sub-prime mortgage market. Mortgage loan defaults cause a lot of angst in Wall Street because some investment banks and hedge funds are big investors in mortgages. The use of leverage has amplified these problems and caused some of these investment pools to implode. Others may be in trouble. The credit crunch was further exacerbated by huge demands for credit from private equity firms hoping to consummate a record amount of corporate buyouts. Under present conditions, some of these loans won't get funded and some of these intended buyouts won't occur.

Credit crunches are typically the result of a broad rise in interest rates and inflation, causing the whole economy to suffer. But this one is different. This crunch is affecting only higher risk borrowers. There is plenty of money available for creditworthy entities. Though pain will be felt by a number of mortgage companies, banks and other investment firms who sought higher returns by taking greater risk, there should be relatively minor and isolated effects on the US economy and the average consumer. There has been some spillover into the REIT (real estate investment trust) marketplace, but well managed REITs should do just fine. Most of the companies in which we invest should continue to grow their earnings, and earnings are the ultimate determinant of stock prices.

I must note, however, that is has been more than 4 years since the market has suffered a 10% correction. Given the nervousness on Wall Street and the appreciation of the stock market over the last few years, a correction could certainly be in the cards. But unless current problems turn out to be a lot worse than I suspect, I don't think we are entering a bear market.

Jeff Friedberg
August 2, 2007