PERIOD FMR*
S&P 500 NASDAQ 100 Russell 2000
1st Qtr 5.0% 4.3% 3.6% 13.7%
2nd Qtr 2.5% (1.4%) (7.5%) (5.3%)
3rd Qtr 1.3% 5.7% 5.0% 0.1%
3rd Qtr 6.5% 6.9% 6.2% 8.6%
YTD 15.5% 15.8% 6.8% 17.0%
The fourth quarter of 2006 continued the strength seen in the third quarter as the market continued to broaden and added another 6% to finish the year up almost 16%. Our Five Mile River portfolio kept pace in the fourth quarter at 6.5% and closed the year with a gain of 15.5% which is at the top end of our expected range for the year of 10%-15%. While energy, utilities, and real estate investment trusts outperformed for the year, the broadening stock market added two other outperforming sectors: telecommunications and consumer discretionary for the first time in several years. More cyclical industries like tires and rubber, autos, metals, and mining were standout performers for the year. FMR portfolios participated in the first three sectors during the year along with a few consumer discretionary names, but we were largely absent from the more cyclical sectors that outperformed in the second half. As the year closed, many of these cyclical names were in strong retreat as the basic commodities and auto stocks began sharp corrections. We have selectively added a few large capitalization growth stocks throughout the year where the companies possess a dominant market share with pricing power and an above average secular demand for their product or service (JNJ, PG, FDX, TEVA). The core of your portfolio continues to be invested in companies selling at a discount from their net asset value and producing more cash than they need to run and grow their businesses. For the past four years, we have focused on owning companies with a culture of paying dividends back to shareholders along with stock buybacks as a hallmark of our investment approach. The reason for this approach is twofold: the first is that total return investing focuses both on dividends and capital appreciation providing for more consistent long-term performance than short-term trading and momentum investing; the second reason is that this philosophy produces lower volatility when the market goes through its periodic “panic attacks” from either financial or political factors that are unexpected. Continuing to get paid real cash in the form of dividends, growing dividends, and special dividends allows us as managers, and you as investors, to take the long-term view to wealth creation and preservation when markets are bumpy.

The interesting question as we start 2007 is whether, after four very good years in a row, our stock market can deliver yet another double digit return in the coming months? The good news is that we believe the answer is “yes” and that the year ahead can produce 10%-15% returns. However, as with our note of caution last year, the road will once again be rough, meaning we are very likely to have more day-to-day and week-to-week volatility. From a historical perspective the average monthly change in the S&P 500 for the last 36 months was 1.87%, whereas, since 1950 over 90% of the months have shown larger price fluctuations. The first two quarters of this year are likely to tread water, as the key question for the year is just slightly different than last year, namely, “When will the Fed ease and by how much?” As we read the economy at the beginning of this year, we continue to feel that the mid-cycle slowdown is the high probability outcome without recession and without re-acceleration of inflation. However, the market will be upset by any data that says the economy is growing too fast or that inflation is in the 2.5%-3% range because that kind of data will absolutely postpone any Fed easing. We expect the market to be more volatile this year, and the substantial upside for the broad market to be limited until the majority of investors can confidently anticipate the Fed Funds rate down 50 basis points at 4.75% (or maybe even 4.5%), and the ten-year Treasury note at 4%-4.25%, with inflation at no more than 2% and stable. We are optimistic that double digit gains are achievable in the market later in 2007, if our forecast plays out as described, and those gains will be able to carry over into an equally volatile but upward trending election year. Another factor that will undoubtedly add to volatility is that this next two-year presidential election cycle will be fairly rare (last time 1952) as this will be a lame duck Republican Party with no Vice President seeking nomination. With both parties believing they can win both houses and the Presidency, the political environment will be hard for the market to ignore and add to the uneven ride we expect.

We thought it might be worth weighing in on the status of the housing bubble that permeated everyone’s conversation for the past four years, and now seems to be more a source of concern as to whether we are still at the early stage or the end of this housing correction. We believe that the “end of the world” housing collapse scenario was not real, but that there were several regional corrections where housing speculation got out of control on the upside and were due for a sell off. Places like Naples, Florida, many coastal towns in Southern California, the states of Nevada and Arizona, and some Northeastern communities witnessed a “cleansing decline” in home prices over the past twelve months. It is important to note that there are many cities around the country that had no bubble and therefore, prices have been stable. No doubt the final year-end numbers will show that housing prices probably posted their first annual decline on record, but from heights that were unrealistic, and born of rampant speculation. Recent evidence that housing is close to a bottom is supported by various housing indices and by homebuilder surveys with mortgage applications actually up in some regions. Housing starts bottom when housing inventory is at a peak and current data suggest that inventory may have peaked in the fourth quarter in many regions, and is likely to peak in the worst cities by early summer. Interest rates on fixed-rate 30-year mortgages have declined to around 6% and builders have sold off speculative land they were holding and slashed housing starts in most of the previously hot areas. Since this bubble cycle was much bigger and longer than anything we have ever experienced, it is reasonable to expect that residential sales will level out and bottom this spring and that prices will stop declining in the most overheated markets this summer. The caveat, of course, is that if you were one of the unfortunate ones who bought the last high priced spec house in Naples, your punishment will be harsher and longer than the buyer in Houston, Texas.

We welcome any questions you might have at any time. Thank you for your continued support.

Thank you for your continued support.

Sincerely,

Todd Robbins Lee Garcia CFA

* Results are unaudited.

Disclaimer

This letter is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendation concerning the manner in which any client’s accounts should or would be handled as appropriate investment decisions depend upon the client’s investment objectives. Any offer to sell or the solicitation of an offer to buy any interests in any securities may be made only by means of delivery of a Five Mile River Investment Management Agreement and or other similar materials which contain a description of the material terms and various considerations and risk factors relating to such securities or fund. Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client’s or prospective client’s portfolio, and there can be no assurance that investors will not incur losses.