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A lot happened during the third quarter of this year, and almost none of it was good. To recap the events of the past few weeks: A segment of our financial sector has been nationalized; we suffered the largest one day drop in the stock market since the crash of 1987; the credit market completely seized up; and investments that were rock solid a month ago have suddenly become very shaky. The rapid worsening of the financial crisis has thrown all of the capital markets into disarray and threatened to spill over into all segments of the economy. We will discuss the scope of the problem and what we think should be done about it, as well as what we think investors should do and not do in response to these extraordinary events.

We have talked in past letters about the housing bubble and the subprime mortgage problems. It initially appeared that the problems were confined to the subprime market, but these problems quickly expanded into a full blown credit and liquidity crisis that has affected leveraged holders of all assets. This lack of liquidity and credit has led to rapid write downs in asset values and an inability to raise the necessary capital to make up the difference. This is how we can go from having well capitalized companies to bankrupt companies literally over night. We have been seeing a classic run on the bank as investors try to dump securities where there is no market, causing prices to tumble.

You need only look at two pieces of data to understand why the capital markets have struggled through the first half of this year; consumer confidence is at its lowest level since 1980; and only 17% of the American people are optimistic about the direction in which we are headed as a nation. This pessimism, driven by a number of factors, directly causes the economy to slow down and stocks to fall. The factors causing this pessimism include the following:

The price of oil and other commodities We have discussed the price of oil often over the past couple of years and it remains an issue. The high price of energy affects almost every segment of our economy in addition to making people feel poorer every time they fill up their car. Food prices and other basic materials are also rising rapidly. This type of inflation has always unnerved consumers and causes them to slow their spending in other areas. A worker making minimum wage spends almost 25% of their weekly earnings to buy one tank of gas for their car. Farmers earn more on their crops but spend huge amounts on fuel and chemicals. Nobody benefits from spiking commodity prices.

Economic concerns and soaring energy prices combined to whipsaw the stock market during the first quarter of 2008. While this is not the first quarterly pullback stocks have experienced since the beginning of the latest bull market in late 2002, it is the most severe. The bond market posted gains as interest rates dropped in response to the slowing economy. There are many questions being asked about the capital markets and we will do our best to answer the most common ones.

Are we in a bear market like the one that lasted from 2000 through 2002? While it is impossible to know what will happen in the future, we are confident that this is not a secular bear market like that one was. Over the past one hundred years, we have only experienced three secular bear markets and they have all come after historic bull markets that drove valuations to record levels. Going into this slowdown, valuations have fallen an unprecedented 50% from the record levels seen in 2000. This should provide a cushion to stock prices.