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December 2006

Despite a slowdown in global growth, a slumping housing sector, and continued geopolitical concerns, the market continues to climb the wall of worry. The S&P 500 was up 1.90% for the month of November, and now stands at a positive 13.51% for the year. Please see Investment Performance page for our results.

With interest rates falling over one hundred basis points in the last five months, it is easy to see why the broad market was granted a multiple expansion based on Greenspan's formula for evaluating fair market value. If you invert a five and a half percent ten year Treasury bond, you come up with an eighteen P/E multiple representing fair value, but at a four and a half ten year, a twenty- two P/E multiple can be justified. With profits continuing to surprise on the upside, it is likely that the rally will continue.

The most attractive long-term investments, however, may well be the same ones that have so dramatically outperformed for the past five years:

• Small cap value. Although the valuations have caught up with big cap, the profits should continue to outpace. The last time small caps outperformed (1974-August of 1982), it was for an eight year period. If history repeats, we're likely to have at least two more years of superior performance.



• Emerging markets. The consolidation may be over, as they appear to have discounted next year's growth slowdown. The best performance should come from countries where interest rates are coming down and the Finance Ministers are easing or about to ease. The PE multiples are still attractive for the most part in both Asia and Latin America.



• Oil. Energy has become range bound, but with a weakening dollar supporting the price and with China's long term secular needs, oil remains a solid investment, as well as a good non-correlating investment to the S&P.



• Gold and Commodities. Commodities as measured by the CRB Raw Industrials index have climbed to a new high again after some consolidation. In addition to a weak dollar, it is very apparent that China is accumulating basic materials with its huge stockpile of US dollars.



• Canada. Canada has been a great investment over the past five years and should continue to be one as the Government has really cleaned up its balance sheet from the brink of disaster a decade ago. Although Manufacturing exports have slowed because of the strong Canadian dollar, their strong natural resource exports have put them in excellent financial shape. With interest rates and PE multiples lower than those of the US, a multiple expansion is a definite possibility.

In summary, with profits and margins continuing to surprise on the upside, and with inflation and interest rates remaining subdued, it is my view that the broad market rally should be able to sustain itself, albeit with additional volatility.

Joe