Second Quarter, 2001

As we begin the third quarter of 2001, optimism in the investment community is growing that the worst of the economic contraction and the stock market decline is now behind us. As of the date of this report, however, such optimism, in our opinion, is based more on hope than on hard evidence. We are reluctant to begin increasing client stock market exposure just yet as the smattering of occasional good news is still being overwhelmed by negative economic events.

Perhaps the strongest reason not to get caught up in the "market bottoming" theory now is that the various stock market indices themselves aren't giving strong indications that the bear market is over. Using past stock market history as a guide, there is a clear pattern of stocks moving higher approximately 3-6 months ahead of an economic recovery, but so far, it isn't happening. Furthermore, we like to look at insider trading as an indicator of current sentiment of the people closest to the pulse of business activity. An analysis of insider trading activity reveals deep pessimism across almost all economic sectors with sellers outnumbering buyers by unusually large margins. The actions of insiders present a stark contrast to the opinions of many top Wall Street analysts who are promoting heavier exposure to the stock market now.

Our assessment of the economy is summarized as follows:

1. Weakness in the industrial side of the economy continues, but the most recent batch of statistics and some anecdotal evidence is showing that the slide in economic activity is slowing in various areas of the economy. A slowing slide is not the same as a recovery.

2. Business profitability continues to decline, as does capital spending, and evidence is mounting of the growing potential for recession in Europe, Asia and Latin America.

3. Domestic unemployment continues to rise, however, consumer spending on housing and autos continues to increase, presumably due to the Fed's series of interest rate cuts. Consumers are acting as if the economic problems described above simply don't exist. Deteriorating economic conditions and strong consumer spending are contradictory trends, however. Sooner or later, something has to give.

4. The worst performing sector of the economy continues to be technology, with companies in the communications fields experiencing very high inventories of unsold chips and other products. This inventory glut is not expected to dissipate prior to year-end at the earliest.

5. Inflation, as measured by the CPI, has been increasing since its low of 1.7% in 1998. It is currently running at a 3.6% annual rate (Fed Chairman Greenspan says inflation is not a problem right now, but at this rate, the purchasing power of a dollar will decline by 30% during the next ten years). We note that long-term interest rates have actually increased since the beginning of the year in spite of the significant decline in short-term rates. The Federal Reserve has no direct control over long-term interest rates.

We have not instituted any significant changes in client overall asset mixes this past quarter. The stock portion of client portfolios remains at the low end of our agreed-upon equity range, regardless of clients' risk tolerance. The bond portion of client portfolios remains relatively short-term for safety purposes, with favorable investment results to date this year. Bond portfolios typically consist of a combination of government and corporate issues as well as shorter-term municipal bonds in particular tax-exempt accounts.