2004 Year-End Update

January 15, 2005

We hope that you enjoyed the holidays and have had a good start to 2005. With another year behind us we are ready to look forward, but first a look at the fourth quarter of 2004.

The fourth quarter of 2004 proved to be a lucrative one for most market participants as many issues were resolved and what appeared to be a cloud of uncertainty finally lifted. As we had stated in our last update, a number of issues came to a conclusion and helped propel the financial markets to their highs of the year. First and foremost, the clean and uncontested victory for President Bush was a huge relief for the markets for two reasons: financial markets tend to dislike uncertainty and market participants appear to have favored a Bush victory which might translate into a more pro-business and therefore pro-market economy. The second sigh of relief came from the lack of any significant terror incident at home or abroad. While the struggle in Iraq continues to weigh on everyone’s mind, the fact that terrorists were unable (or chose not to) stage a significant attack was a huge relief. This is not to say that future incidents are less likely or even diminished at this point, however it was a concern during the fourth quarter surrounding the election and the holidays. Another positive for the markets was the retreat in oil prices to more sustainable levels. While few would argue that the price of oil and natural gas are cheap, it was clearly a move in the right direction for the markets and consumers alike. Whether the current price levels are sustainable is a topic of debate, however the fourth quarter proved to be a leveling off period for energy. Finally, the domestic economy showed some signs of life again, a major concern during the third quarter of last year. We began to see what appears to be an improving job market and earnings came in stronger than many had anticipated. The weak third quarter allowed us to pick up a number of what we considered “good values” and we were able to take advantage of the much improved market climate as a result.

This brings us to the first quarter of 2005. Again, we are optimistic about the macro-economic environment going forward, however we are not without some concerns. As stated above, the uncertainly surrounding the political front has been erased, at least for another four years. Whether or not one believes President Bush is the right man for the job, the choice has been made and the market likes this certainty. Should Bush be successful in implementing his plans to make tax cuts permanent and overhaul the Social Security system, the financial markets should view this as a positive for the near term. On the energy front, we believe that the price of oil has reached a more sustainable level, at least under current circumstances. The possibility of the much talked about “terror premium” becoming an issue once again is yet to be seen. However, barring any major supply disruptions it would appear that energy prices have stabilized for the time being. Unfortunately, it is likely that we will be listing terrorism as a concern for a long time to come. Again, as we stated in our last update, it does appear that our government, along with others across the globe, have made substantial progress in reducing the probability and severity of any future attacks. That being said, it cannot be ruled out and we can only hope that any future attacks are mild at worst. One potential headwind in the macro-economic forecast is the falling dollar. While a cheaper dollar has both benefits and drawbacks, our view is that any large scale damage to the global economy will be minimal as long as a change in the dollar’s value is gradual. In other words, it is the speed in which the change occurs that is more concerning than the direction itself. Making bets on the direction of currencies is a tricky business and one we do not participate in, however we are of the opinion that the movement in the dollar will be gradual and therefore will have a fairly benign effect on the world’s economies.

In conclusion, while we are pleased that 2004 was generally a positive year, we are disappointed that our results were not better. The reason for our dissatisfaction is due primarily to the difficult third quarter that we experienced. While we quickly recovered from this setback it was a definite hurdle that weighed on 2004 results. On the bright side however, we are extremely optimistic about the outlook for 2005 for many reasons. One example not mentioned above is the improved climate for merger and acquisition activity. Corporate balance sheets are flush with cash and it’s most likely use will come in the form of either stock buybacks, good for the market as well, or M&A activity. We welcome this opportunity as it provides a backdrop much like 2000, a year in which the indexes were down sharply, whereas our clients performed extremely well. We have our clients’ accounts well positioned for this market and we will continue to work hard to make money for each and every one of them. We appreciate the confidence and trust you have shown in us by hiring our firm as your investment manager.

Cordially,

Paul R. Ray III Brian M. Phillips