Counterpoint — A Commentary of Jurika, Mills & Keifer LLC
Special Update: August 20, 2007

Financial turmoil creates opportunity

In search of F.W.M.D.s

Dear Investors and Friends:

We warned in our recent market commentary that “A sea of liquidity can become a desert overnight.” We saw this happen in July and August as credit markets seized-up in response to the continued fall-out from the mortgage market and the many leveraged bets made upon mortgage-backed securities.

The fallout is not surprising to us. The flood of easy money and lack of any meaningful premium required to differentiate assets based on quality and risk, combined with high fees and incentives to stretch for return with other people’s money is a sure recipe for disaster.

Smart people can do some foolish things, especially when derivative bets on “highly predictable” outcomes are combined with leverage to enhance potential return.

Until recently, this has been a winning formula. Hedge fund managers could borrow cheaply and add a pile of leverage to a seemingly sure-thing bet on some highly predictable outcome investment like mortgage-backed securities to produce a very attractive absolute return, even after deducting a generous management fee.

But you can also count on the fact that once Wall Street discovers a good thing, it will take a good thing too far. Investors happily gobbled up these securities, and Wall Street firms happily obliged by making more, proliferating F.W.M.D.s (financial weapons of mass destruction) throughout Wall Street and the economy.

As we have seen over time however, investments with highly predictable outcomes sometimes behave in highly unpredictable ways, especially during periods of market turmoil when theoretical valuation goes out the window and a security is only worth what someone else is willing to pay for it. Then, the leverage can have the opposite effect, causing a virtuous cycle of margin calls and forced liquidations. A “perfect storm” of unfortunate circumstances.

Many  investors have an uncanny way of failing to anticipate perfect storms, and perfect storms have an uncanny way of happening.

In our view, proper pricing of risk needs to and will return to the financial markets. This is in progress and there will likely be more dislocations ahead.

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We see this as an opportunity. With fear, uncertainty and panic prevailing, good assets are being put on sale with the bad. We believe this is a good time to be investing.

Many good companies are being sold to raise cash, either as a result of forced liquidations, or people just wanting to reduce market exposure.

The U.S. economy is still strong and the global economy is growing. Stocks valuations are reasonable, especially among very large multi-national companies, certain financials, and any company with any “hair” on it. We always love a little controversy and controversy is now on sale.

The private equity/hedge fund buyout craze may over, at least for the time being, and stocks that had been valued as take-out candidates will now be valued on fundamentals. This is a good thing.

But strategic buyouts and stock buybacks will most certainly continue. There are many good companies sitting on piles of cash that will put it to good use to acquire competitors or other companies that create new capabilities, or to buy in their own stock.

Although this environment has taken a near-term toll on some of the companies in our portfolio, we think the values and the opportunities are very attractive and we are putting new money to work.

We continue to invest with a very focused, if slightly unconventional approach: find good companies with strong franchises that offer good value relative to their potential; concentrate our capital in relatively few of these investments so that we can focus our efforts and can make our insights count; take a long-term view and try to minimize turnover. This is where we have our own money invested, alongside yours, and we have learned over the years that less can be more.

On behalf of everyone at Jurika, Mills & Keifer we want to thank you for your ongoing trust and your investment with us. As always we welcome your questions, comments, referrals, and the opportunity to be of assistance.

Karl O. Mills, CFA
Jurika, Mills & Keifer

Important Disclosures

Past performance is no guarantee of future results.

Opinions expressed are those of Jurika, Mills & Keifer, LLC and are subject to change, are not guaranteed and are not recommendations to buy or sell any security.