"No man is an island, entire of itself; every man is a piece of the continent, a part of the main; if a clod be washed away by the sea, Europe is the less, as well as if a promontory were, as well as if a manor of thy friends or of thine own were; any man's death diminishes me, because I am involved in mankind; and therefore never send to know for whom the bell tolls; it tolls for thee."

-Attributed to John Donne,
Devotions upon Emergent Occasions, 1624

The bells have tolled for many thousands of Americans and citizens of more than sixty countries since the heinous mass murders of September 11. And so, too, they have tolled for all of mankind. For we are all part of one world inextricably intertwined in life's pursuits. A part of Everyman has died and washed away in a sea of hate. The cauldron of extreme hostility has bubbled over onto a world stage that finds the fabric of capitalism, modernity, and an open society besieged by a fanatical legion of Islamic fundamentalists who, in their pursuit of a political agenda, have debased the teachings of a religion followed by one-fifth of the world's population.

What are we to make of such seeming madness and fury? When both sides appeal to either God or Allah to justify their calls to battle, is one side necessarily good and the other evil? We have seen the scarred face of evil from time immemorial. In the twentieth century, it manifested itself in the horrific totalitarian state of Russia when Joseph Stalin and other communists killed over ten million of their own citizens in pogroms and the gulags. Adolph Hitler and his band of sociopaths murdered millions of European and Russian Jews and other innocent civilians in a sustained campaign of genocide. In the aftermath of the Vietnam War, the Pol Pot regime massacred possibly as many as three million people in the killing fields of Cambodia. Some would argue that the German bombings of civilians in London and the fire bombing of Dresden and other German cities by the allies during World War II was evil as well. And the A-bombs dropped by the U.S. were viewed by many as a horrible escalation of war. For decades, terrorist attacks throughout Europe, the Mideast, and Africa have been visited upon civilian, military, and embassy facilities of a number of nations, killing untold thousands. In recent years, we have seen Saddam Hussein unleash poisonous gas on the Kurds of northern Iraq.

Sadly, the dark side of mankind continues to erupt, wreaking havoc on its fellow man. On September 11, a fusillade of terror at the hands of hostile foreigners brought death to American soil by invasion tantamount to an act of war for the first time since World War II. And the perpetrators are calling for a holy jihad against the American and Jewish "infidels" and their allies. We now face a world that is filled with an uncertainty that is very different than past periods of conflict in American history. During World War II, caricatures of Tojo and Hitler epitomized the empires against which the Allies marshaled their resources. During the Cold War period of the 1950s through the 1980s, the concept of mutually assured destruction, with the appropriate acronym of MAD, enabled the U.S. and the U.S.S.R. to hold each other at bay. At least the Soviet leadership valued life, vodka, and their dachas. Not so, the zealots of radical Islamic fundamentalism whose terrorist acts and threats appear increasingly nihilistic. For them, to die fighting the unbelievers is to be carried to heaven.

Are we now facing a modern dark ages of attack, retaliation, horror, and constant fear? Although no one on this planet knows what the future holds, we believe the worst predictions of the doomsayers will not come to pass. It would be a mistake to make the terrorists ten feet tall. The governments of the industrialized world are far from powerless to deal with the vermin of terrorism. The U.S. and many other governments, some of which have previously winked at terrorism, are gearing for a sustained battle to be waged on many fronts. If there is a silver lining in the aftermath of September 11, we would say there are two. First, for many in this country and other countries around the world, there appears to be a reassessment of the importance of the collective values of humanity, community, civilization, and international interdependence. Second, there is a newfound recognition that a war on capitalism and economic globalization is a war on all countries that aspire to achieve a higher standard of living for their citizens. Can China and Japan expect to export large amounts of goods and services to the U.S. and Europe if western economies are in decline? Will Americans, Europeans, and Asians be willing to travel freely and spend billions of dollars on business and tourist activities if the world remains in a state of immobilization through fear? Will the moderate Arab states be able to export oil at high price levels if demand plummets because of a sustained economic downturn? Will Russia and China be able to contain radical Islam in key areas of their nations if state-sponsored terrorism continues to thrive in the Mideast? The bells are tolling not only for those who have lost their lives, but they are pealing a warning to world leaders to eradicate the poison spewing forth from hate mongers and their sponsors around the world.

While the initial response of the U.S. and other countries has centered on the infamous Osama bin Laden and his immediate disciples, the crux of the terrorist problem rests with those nations that harbor and facilitate terrorism. The stakes are high. Modern terrorism is particularly heinous. It has harnessed modern technology and weapons of mass destruction, funded in large part by drugs and armament sales, as it pursues political agendas while masquerading in the garb of religions that have been defiled. Until the industrialized economies expunge state-sponsored terrorism, the world will remain a very unsafe and uncertain place. What does this mean for the U.S. and its various coalitions of allies? In the final analysis, it will mean that the U.S. may have to use significant military force against certain nations in the Mideast should they fail to cease and desist in their de facto war against the U.S. We do not think this campaign will take on the character of a major war, but it is not hard to imagine a more dangerous set of developments, however improbable they may seem today.

To wit: As tragic as the recent attacks on New York and Washington were, would we as a nation be willing to countenance an even more horrific set of events that might encompass biological or chemical warfare with an even greater loss of life? We think not. Senator John Kyl of Arizona said that the U.S. should not rule out the use of nuclear weapons against terrorist states if such attacks were waged against the U.S. and its citizens. Such statements may seem reminiscent of Barry Goldwater in 1964, but it would be no great shock to see an increase in national outrage if terrorist attacks against the U. S. result in thousands more dead on U.S. soil. In the summer of 1945 as the U.S. was preparing for a land invasion of Japan in the pursuit of an unconditional surrender, kamikaze pilots demonstrated to a resolute President Harry S. Truman that the Japanese nation could possibly inflict as many as one million casualties upon American forces if Japan were invaded with ground forces. He chose to unleash the hell of the atomic bomb instead. After Hiroshima and Nagasaki, Japanese Emperor Hirohito sued for peace.

Today, the potential for such an alarming set of similar developments is a major reason that we think much of the world's nations are now taking a more vigilant stance to stem terrorism, thus precluding such a horrendous escalation as referred to by Senator Kyl. But their resolve must be long-lasting.

Certainly the long-term key to dealing with terrorism is to immobilize its support from sponsoring states, address the Israeli/Palestinian issue, foster economic growth in the Muslim world where poverty provides a breeding ground for dissidents, and win the hearts and minds of Muslims through an effort on the part of moderate Muslim clerics to inculcate the true teachings of Islam among its people. A tall order, for sure, but one that is achievable. It took forty years to win the Cold War, but it was finally won with information and a will to prevail, not bullets and missiles.

At this very critical time in world history, the world is embroiled in a battle between the dark forces of the netherworld and the champions of capitalism and a free society. Capitalism, for all of its materialism and attendant corruption of the soul in the minds of many, has fostered political freedom through economic liberty. Benjamin Franklin said, "They that can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety." President George W. Bush has called out to the world, "Either you are with us, or you are with the terrorists." Wisely, he extended the warning to those states that harbor terrorism. Should America and its allies shrink from this battle for a brief period of perceived safety through compromise and expediency, they will no longer be safe, and what remains of their freedom will be hollow.

The faceless armies of terrorism and their supporters certainly have the will to wage their war against the "Great Satan," but they do not yet have the power of the western world. The U.S. and the pursuers of capitalism and modernity throughout the world have the power to wage a successful war against terrorism, but do they have the will? The initial signs are that they do. If this nation is challenged even more fiercely, its resolve will become even greater. Our confidence in the underlying benefits of economic and political liberty, and the willingness demonstrated by mankind to fight for it in the last few centuries, give us faith that, after a time of battle, some peace can come again to this world.

The teachings of Islam and the Judeo-Christian heritage both offer hope for the future as the world faces the first war of the twenty-first century. It is in that context that we conclude this section with, first, a passage from the Koran, Chapter 1: 1-3:

"In the name of the most merciful God: Praise be to God, the Lord of all Being; the most merciful, the Master of the day of judgment. Thee do we worship, and of Thee do we beg assistance. Direct us in the right path, in the path of those to whom Thou hast been gracious; not of those against whom Thou art incensed, nor of those who go astray."

And from Ecclesiastes, Chapter 3: 1-8:

"To every thing there is a season, and a time to every purpose under the heaven. A time to be born, and a time to die; a time to plant, and a time to pluck up that which is planted. A time to kill, and a time to heal; a time to break down, and a time to build up; A time to weep, and a time to laugh; a time to mourn, and a time to dance; A time to cast away stones, and a time to gather stones together; a time to embrace, and a time to refrain from embracing: A time to get, and a time to lose; a time to keep, and a time to cast away; A time to rend, and a time to sew; a time to keep silence, and a time to speak; A time to love, and a time to hate; a time of war, and a time of peace."

RECESSION TODAY, RECOVERY NEXT YEAR?

Prior to September, the U.S. economy was already flirting with a recession. One is now assured. As dismal as the implications for corporate profits are for 2001, the uncertainty surrounding the depth and duration of an economic downturn and the strength of a subsequent recovery further eroded already fragile investor expectations. The freefall in stock prices that accelerated post attack signaled a major adjustment in both the expectations for corporate profits and a higher level of perceived risk attached to the future economic outlook. Given the shock to the domestic and global economies, the damage to corporate profits can only be guessed. It would be naïve to attach a high level of certainty to corporate profit estimates for the remainder of 2001 and 2002. As far as 2001 is concerned, any expectations for earnings have become almost irrelevant in terms of their impact on stock prices. And the unique nature of the economic gridlock in which the U.S. and other industrialized countries now find themselves makes projections for next year educated guesses at best.

In the face of such an uncertain environment, particularly in the near term, it would seem prudent to focus on the implications for investments with a long-term horizon in mind. From this perspective, we can have some comfort that the future for investment returns is far from dire, and under some circumstances could be quite promising. Looking forward, our underlying assumptions are that the U.S. and other key nations will deal with terrorism and its awful consequences. True, the escalation of terror has injected much greater uncertainty into the economic picture around the world, but it has also awakened the forces to counter its sources and sponsors. The war on terrorism will be ratcheted to a higher level of intensity and sophistication. Coupled with an attack on the dens and states of terrorism, it would be unrealistic to think that the terrorists will prevail in such a way as to permanently destabilize world economies. Although the effort to contain terrorism will have its victories and defeats, as people begin to perceive progress toward a reining in of terror, their confidence in the future and a sense that a return to a new level of normalcy will evolve will cause a shift to more positive attitudes toward risk and investment as well.

The direst projections about the impact of terrorism on economic activity are not likely to occur. Israel, continental Europe, the United Kingdom, and Northern Ireland have dealt with terrorism for decades. Yet economic growth has still thrived in these areas at a fairly healthy pace. Corporations invest in the future; consumers still buy homes and cars, take vacations, eat out in restaurants, and attend sporting events. We are confident that U.S. citizens will not remain prisoners of fear forever.

In view of these underlying assumptions, what should investors expect in coming quarters and years? Perhaps the only thing that can be said about the near term is that it will be event-driven and characterized by volatility. A new terror attack of magnitude would be particularly demoralizing to the nation and investor psyches. On the other hand, tangible success on one or more fronts against the terrorists and their sponsors would probably instill great confidence among investors with a corresponding shift to a much more positive outlook for corporate profits and equity prices. But it is not only events in the immediate future that will play a role in stock price movement.

Well before September, some key steps were taken aimed at stimulating economic growth. After September 11, additional firepower has been brought to bear to stem the economic downturn and foster renewed growth. Most notable has been the lowering of interest rates by the Federal Reserve. Since January and prior to September, the Fed lowered interest rates on seven different occasions, reducing the federal funds target rate from 6% to 3.5%. Since the attacks, the Fed has lowered rates twice so that the Fed funds target stood at 2.5% on October 2. Additionally, the Fed has provided enormous sums of liquidity to the banking system and the economy through their open market operations, and they have signaled their willingness to continue supplying liquidity to the markets.

In addition to the aggressive actions of the Federal Reserve, stimulus has also been provided by tax cuts. While the initial tax rebates have been viewed by many as too anemic, they have had some positive impact. More importantly, tax rates will gradually continue to come down, placing more funds in the hands of consumers. While the Fed's role and the tax cuts have certainly been positives, the dynamics of fiscal and taxation policy have taken on a decidedly stimulative tone in the days immediately following the tragedy. The initial steps taken by the U.S. government after the attacks appear likely to be followed by even more stimulative measures targeted at restoring economic growth. In some cases, especially in the area of defense and intelligence spending, their effects will be significant. The actions taken to date coupled with those that are likely to be instituted in the near future will serve to boost economic activity in 2002 and subsequent years.

While the Federal Reserve and U.S. government officials have launched stimulative efforts at home, European central bankers have also cut interest rates and will probably continue to do so. They have also reduced taxes as well. The Japanese, in a more constrained economic situation, are taking painful but necessary steps to jump-start their economy. The leaders of the industrialized world have finally recognized the need to engage in an aggressive campaign to galvanize economic growth. These aggressive steps for growth on a world scale will begin to bear fruit with a corresponding salutary impact on corporate profits and stock prices.

Again, we think a sense of normalcy will return to businesses and consumers as we progress through the next several weeks and months. As the power of monetary policy, fiscal programs, and lower taxes come into play, the engines of economic activity will begin to run faster. The bleak headlines of today will yield to stabilization and then recovery. As confidence in the future is gradually restored, investors will wax more positively about the long-term prospects for economic growth. Their future behavior will be in stark contrast to the recent fear that has gripped the investment world.

There are a number of barometers signaling that perhaps the worst of the decline in stock prices is possibly behind us. Various market, technical, and fundamental indicators have recently reached levels that have previously marked significant turning points in a bear market. And although we do not expect a resounding V-shaped rally off of the recent price levels reached by equity securities, we do not anticipate a further dramatic decline. Investors have had a rather negative outlook on the markets for some time, and this outlook has led them to liquidate securities at a very steady pace at the same time that cash levels have been increasing dramatically. At the beginning of October, there was over $2.0 trillion in money market funds, the highest absolute amount on record, roughly 23% of the U.S. equity market's total capitalization, surpassing the previous record of 1982. With money market yields now ticking below 3% in many cases, the appeal of these funds and other cash proxies is significantly diminished. Such measures as put-to-call ratios, short interest ratios, margin debt, and investor sentiment are all flashing signs of a potential change in direction. All of these and other readings of investor activity are indicative of a very, very negative mindset on the part of both institutional and individual investors. Historically, when such readings have reached such extreme levels as occurred during the weeks prior to September 11 and the week of September 17, they coincided with major market bottoms. On top of these market statistics, it should be noted that there has been a very high and aggressive level of short selling conducted by a large number of hedge funds and individuals as well. There is an old saying on Wall Street, "He who sells what isn't his'n, must replace it or go to prison." At some point, these short sales have to be covered. We doubt that so many hedge funds and late blooming short sellers are all going to be correct in their expectations that such a large number of stocks will continue their declines. When the markets stop their descent and show signs of an upturn, the short sellers will be competing to cover their shorts at the same time that cash rich investors will be scrambling to get back in.

In the wake of the tumultuous events of the last few weeks, many new variables have been injected into the outlook for bonds and stocks. A pall will continue to hang over the markets in the immediate future pending any highly positive developments on the military and intelligence front. Undoubtedly, some of the effects will be long-lasting in nature while others will prove transitory. Where there is uncertainty about particular industries, (i.e. airlines, hotels, leisure, auto-rental) the negative impact may take some time to alleviate. Other industries (i.e. defense, food retailing, healthcare, cable TV) may have a higher level of predictability. These new dynamics will require a viewpoint as to their short-term effect and to their long-term effect. The markets are probably going to be marked by a high level of volatility as events unfold. Much of the short-term effect has already been factored into stock prices, even more than is probably warranted in some cases. We think it is critical to focus on the long term. It is even more important to have a fundamental basis of the intrinsic value of a business under a normalized set of circumstances. A framework for the benchmark value of a business and its stock price will serve to insulate investors from much of the inevitable emotion and corresponding volatility that will be washing back and forth over the markets in the near future. Likewise, if one can look down the road a few quarters or a year or two from now and have a reasonably good idea of the intrinsic value of a business, whether it be a value stock or a growth stock, it should serve as a guidepost as to whether or not a company's stock is a good investment.

Our Business Valuation Approach seeks to identify those companies that are undervalued in the public market in the context of a time frame that typically extends out one to three years. During past periods of great uncertainty it has proven to be a particularly useful methodology for investing in common stocks. Of course, common stocks are not the only place in which we can invest client funds. In our balanced accounts, we have meaningful holdings of fixed-income securities. Bonds have provided a refuge for capital in recent months and have provided a reasonably good overall return. We would like to note, however, that in coming months we think the risk/reward for stocks will be decidedly better than it will be for bonds.

In the face of the dramatic changes that have occurred in recent weeks, we have reviewed the portfolio composition of our client holdings. We have made some changes in those cases where we think either the near-term or the long-term dynamics dictate a significant change in fundamentals and potential price performance. In some instances we have added to positions we have held for some time; in other cases we have exited our positions in a particular security. This process is a never-ending one that has taken on a more intensive review recently. For our taxable accounts, we are also cognizant of the need to minimize any potential tax liability without sacrificing potential long-term performance. Most importantly, our outlook for the longer term is a cautiously sanguine one. Accordingly, we are willing to look over the valley of present uncertainty at what we think will be a transition to a much more positive environment in the months and years to come.

We face two major challenges in the days, weeks, and years ahead. First, we must protect our nation, its people, and our interests at home and abroad against further terrorist activities. Second, and very important for the long term, we need to rebuild and strengthen our economy by unleashing the entrepreneurship and creativity that have generated the prosperity of this country throughout its history. We are confident that these two goals can be achieved.

OVERSOLD - READY FOR RECOVERY
% Change Through September 28, 2001

Roger E. King, CFA
Chairman and President