PERIOD FMR*
Taxable Estimated
FMR*
Retirement Estimated
S&P 500 NASDAQ 100 Russell 2000
1st Qtr (6.40%) (5.81%) (9.44%) (14.53%) (10.19%)
2nd Qtr 3.61% 4.33% (2.67%) 3.10% 0.25%
1st Half (3.03%) (1.73%) (11.95%) (11.89%) (9.97%)
The increased volatility that dominated the U.S. stock market in the first quarter continued unabated during the second quarter, with the S&P 500 at -2.67%. FMR portfolios outperformed the S&P again in the second quarter and were on average approximately +3.76%. Year to date, the S&P 500 is now -11.95% and the average FMR portfolio is -2.77%. While our portfolios have clearly been impacted by this difficult sideways market, we have continued to position our portfolios more defensively over the past year to soften the impact of the housing and credit crises on portfolio values. Economic growth is virtually non-existent and has continued to bump along in the 0%-2% range over the past few quarters. We expect this no growth, no recovery scenario to continue to play out through the remainder of this year and at least through the first half of 2009. Inflation from the dramatic oil price increase is now the third major concern for our economy and we have been able to take advantage of this increasingly tight supply/demand environment for energy with significant energy portfolio holdings in natural gas, oil service, propane, storage, and pipelines. FMR has also had a small but helpful exposure to the agriculture and utility sectors which have been performing very well. Nuclear power and wind power will be among the long-term answers to our over dependence on imported foreign oil. Our investments in Entergy, Exelon, FPL Corp, Dominion Resources, and Constellation Energy should benefit FMR portfolios as these companies will be in the forefront of developing needed incremental power sources.

Sideways markets, which can act and feel like bear markets for many sectors, are always difficult to navigate such as in the case following the long bull market from 1982-2000. While earnings are important, the driver for such markets has almost always been the compression of high market valuations. During bull markets, the combination of P/E expansion and earnings growth brings big positive returns. However, the bull market that ended in 2000 had the highest valuations (P/E) in the 20th century. When P/E’s reach excessive levels as they did in 2000, typically they revert to average or below average valuations, which is what has been happening over the past eight years. The result has been meager returns for investors who hold a typical “market” portfolio. This kind of environment is one in which active “value” investing pays off and can outperform buy-and-hold investing or passive indexing. It pays off because your portfolio should decline a lot less whether this is a sideways market or a bear market.

In past quarterly letters we have talked about what our version of active “value” investing means and used several of our portfolio holdings as prime examples. At the risk of repeating ourselves, we are looking for and investing in high quality sustainable business models that have a competitive advantage, strong balance sheets, free cash flow, and management whose interests are aligned with ours as shareholders. We like to buy these companies that often own real assets at a discount to their net asset value or intrinsic value versus focusing on relative P/E ratios. We also have over-emphasized the importance of dividends and dividend growth as an anchor to long-term performance results. In fact, during sideways or bear markets, as much as 90% of your return comes from dividends versus about 20% in bull markets. Furthermore, in bear markets, dividends reduce downside volatility, particularly in a low-interest rate environment. FMR portfolio companies have one or more of these financial or fundamental characteristics and offer long-term dependable upside performance.

We would like to comment on how to be a successful investor in such a negative climate where one is continuously bombarded by a seemingly endless supply of bad news. In order to maintain some kind of equanimity you need to think like a contrarian in order to avoid selling out at the bottom when it is far too late and much of the bad news has already been discounted. We have frequently commented that market timing is almost always a fool’s game as it requires an investor to be right twice in a row at critical turning points. This feat is extremely difficult to accomplish on a consistent basis and as we said in our last letter, it is not a game we know or are comfortable in trying to implement. Let us give you some hard numbers to make our point clear. If an investor was fully invested in the S&P 500 index from 12/97 to 12/07, your cumulative ten year return was +78%. However, if you missed the TWENTY BEST days of the stock market in those ten years, you would have LOST 24%! Therefore, a patient long-term investment horizon, combined with an active “value” strategy to avoid short-term underperformance, is a game plan that can survive turbulent markets and will create long-term wealth. This strategy is exactly what we have put in place for both your taxable and qualified retirement accounts. We expect this approach will continue to preserve capital in down or sideways markets and build wealth in future up markets.

Please call or email your questions to us at anytime as we would be glad to discuss any aspect of your investments or financial plans.


Sincerely,

Lee Todd Martha

*The foregoing information is not audited and has not been otherwise reviewed or verified by any outside party. While Five Mile River Investment Management, LLC endeavors to furnish accurate information, investors should not rely upon the accuracy or completeness of this information.

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.