July 30,2007

Volatility Returns to Equity Markets

Stock markets around the world fell sharply last week. Although we can expect the markets to be volatile, higher stock prices lie ahead.

I write after the sharp decline in global stock markets last week, to offer a view on the increasingly volatile markets and to explain an investment change made today. It appears to me that stock markets have not yet made their highs for this bull market. The way will probably be increasingly bumpy; the wide price swings we have observed since February of this year will probably be the rule, not the exception.

Global economic growth and corporate profitability remain strong. Stock prices, despite having risen at a healthy rate for some time, are not exceptionally high. Higher prices lie ahead.

As you know from these letters and from observing your portfolios under our supervision, we have held fairly large positions in US and foreign currency money market funds for a few years. The size of these positions varies among client portfolios according to our assessments of clients’ risk tolerances. These money market funds, of course, are not subject to the risks of stock markets and they have been paying decent dividends. Not only have the foreign currency funds paid dividends; they have appreciated modestly as the dollar has declined.

We have also limited risk in client accounts by our investments in physical commodities, which we have held since the beginning of 2004. Commodity prices have risen in these three and a half years and our portfolios have benefited directly from the higher prices for oil, industrial and precious metals, and agricultural commodities.

In recent months, I have observed that the prices of many commodities have grown faster than the stocks of the companies involved in their extraction, refining, and transportation. To give an example, crude oil prices have risen faster in recent years than the stocks of companies in the oil business. This situation obtains for a number of commodities and the related equities. Hence, I sold our positions today in physical commodities (mostly through the mutual fund Pimco Commodity Real Return fund, symbol pcrdx). I plan to use proceeds from these sales to buy equities in industries (within and without the United States) involved in commodities. We have held profitable positions for several years in energy stocks and utilities, both significantly involved with oil, coal and natural gas. I expect in coming weeks to make other investments in these areas, as well as in alternative energy and water-related industries. The present market weakness may provide us with the opportunity to make these investments at favorable prices. Happily, as stock prices have fallen in recent sessions, commodity prices have appreciated a bit, enabling us to sell our commodity positions at good prices.

Stock markets have been increasingly volatile this year. I expect this volatility to continue.Because we have large cash reserves, we have capital available to take advantage of opportunities that weak stock markets present

Stock Market Volatility.The adjacent graph shows volatility in the stock market, as measured by the so-called VIX index. VIX is derived from premiums on options on a US stock market index. A higher level of the VIX indicates that price swings in the market--up and down--are higher. Two observations about this: First, for the last four years, stock market volatility has been falling from the very high levels that prevailed from 1998 to 2002, the period of the Asian currency crisis, Russia’s default on Soviet-era debt, the dot-com bubble and the subsequent bear market. Since that time, which marked the beginning of this bull market, stock markets have experienced small swings. Markets have been increasingly placid; volatility has fallen. Second, the decline in volatility probably came to its end early this year. We may expect to witness rises and declines in stock market of greater magnitude.

Bigger swings up and down put a premium on a deliberate, unemotional approach to investing. As price swings increase, the news about the stock market becomes louder and more urgent. An approach that lowers risk while markets are strong provides a calmer perspective for judgments when markets become unsettled, as they are now. Because we have held large cash positions, our portfolios suffer less when stock markets fall. Additionally, because of the large money fund positions (increased today by our commodities sales), we have funds available to take advantage of bargains in the stock market. Present market conditions are favorable for investors like us.

Please call (800 451 2240) or email (JNMayberry@coreasset.com) if you wish to discuss your investments.