It would be my best guess  that we are now in the latter stages of the credit/liquidity crisis. There will still be considerable volatility and additional failures, but I believe that the governments of the world have done enough, or have committed to do enough, to stop the bleeding and unfreeze the world's credit markets. The path will not be smooth, but I now believe my most extreme scenarios have been averted.
 
        This doesn't mean that we will avoid a recession and I believe that the recession will be quite severe with significant unemployment and continuing erosion in asset prices, including real estate. There will be bank failures and corporate failures and a lot of localized distress and distress in the world economy. In some places, the recession will probably resemble a depression. I believe that we will have a period of very muted inflation and, probably, actually experience deflation. I also believe that all of the actions taken over the last month will, in the long term, have adverse repercussions for the US dollar and for US economic dominance. But that is a battle for another day and isn't relevant to any current analysis.
 
        As a portfolio manager I am obviously involved, on a continuous basis, in the sensible allocation of your capital. This means that I am constantly assessing valuations of all types of asset classes and individual holdings. The current situation is as follows:
 
1. Treasury Bonds and Bills
 

The latter is where we hold the bulk of our cash assets and have for many months. The rates are lower than money market funds, but there is zero risk of capital loss. We will continue to invest our cash in this fashion. At rates of 4%, longer term Treasury bonds are not attractive and have a significant risk of capital loss.
 

Unattractive for a variety of reasons. Anything longer term is vulnerable to the eventual after-effects of this explosion of credit. Quality bonds and speculative bonds do not offer enough yield to offset the risks of eventual inflation, corporate failures or potential downgrades.
 

Domestic residential real estate still has a way to go until it finds a sustainable bottom. The flood of foreclosures will dramatically delay this process. Commercial real estate is, simply, a disaster waiting to happen. Some distress already exists with much more to follow as the effects of this crisis and the recession are felt throughout the economy. The only real estate that I find interesting is high quality Asian real estate selling at a substantial discount to an already depressed price (RMR Real Estate) and some parcels of raw land in the U.S, selling at large discounts to realizable value (Tejon Ranch, Consolidate Tomoka).

4. Precious Metals
 

I have my usual 5% disaster insurance position. Apart from a 1% holding in silver, the rest is in gold mining stocks rather than the physical metal. This hasn't worked out as well in the crisis as I, or anyone else, would have guessed as gold has been up, but the stocks (which usually move with gold) have been down significantly. I think this position will perform excellently in the year ahead as it returns to its normal relationship with the underlying metal.
 

The bargains that currently exist are, frankly, making my mouth water. The quality of the companies and their valuations offer a combination that is rarely seen but, of course, there is a reason for this- the crisis and the fear that is everywhere amongst all market participants. I think most rational observers can see the values, but are scared because they have absolutely no idea of the timing or price of the eventual bottom. I, and most value investors, know that timing the bottom is impossible and that the smart thing is to buy when securities are cheap on an absolute basis.

The characteristics of the stocks we own and will own are that they are financially strong; have a weighted average dividend yield of 5.9% and are selling at 7.5 x 2008 earnings.They have also, in the aggregate, fallen by 52% in the last 12 months (i.e.- they will need to increase in price by 100% to make a new high for the year). In aggregate they are selling at the same prices they first reached in 1998!

Do we think that their earnings will go down in 2009? Yes, almost certainly despite the fact that most of our holdings are in the defensive areas of drugs, telephone and utilities. Do I think this is the low? As I said, I have no idea and they may fall substantially from this level, but they are already absolute bargains at current prices.

One of the main reasons that we might see lots of price pressure is that many people are capitulating and selling all or most of their 401K's and ordinary mutual funds and the funds in turn are being forced to sell their holdings to meet redemptions. As I have said with many of the most well known funds down for the 12 months between 35 -45% (Fidelity Magellan, Longleaf, Third Avenue, Legg Mason value, Dodge and Cox etc.), redemptions will be inevitable and might be significant.

     So this is where we are at this point. I plan to continue to add stock as absolute bargains appear, but I am also very aware that some of you might be uncomfortable with the potential paper losses and might want us to, in your cases, reduce the risk in your portfolio. Please call us and let us know if this applies to you or, if you wish to ask more questions. Nancy will be happy to answer any questions you may have. As you know my money is managed in exactly the same fashion as yours and I have actually increased my risk profile in the current marketplace.
 
     I believe there is a strong probability that we will be rewarded significantly, but I also believe it will be some months before we start to see the performance. In many ways this reminds me of the fall of 1974 when I was a heavy buyer of securities, which continued to fall for several more months and then, in 1975, soared in value. This was also true, to a lesser extent, in 2000 where the values took longer to realize. After the crash of 1987, the large purchases we made in the immediate aftermath rewarded us almost immediately with significant gains. In other words the timing of the rewards is unknown, but I think we can be reasonably sure of the rewards.
 
    As I said call us with questions and to clarify anything that is unclear.