To: Account Executives, Friends and Allies

From: Andrew E. Beer, Chief Investment Strategist for the AFS Group

Date: July 10, 2000

In order to make more comprehensible the current trends of strategic thinking that underlie trends of stock prices and the changes taking place, we will review in this issue some historical prospective; current cross currents and anticipations of market action in the near future.

Historical Perspective

For those who study very long business and market cycles, the Great Depression from 1929 through 1942 represents a node for the Kondratiev Wave. Kondratiev waves are named after Victor Kondratiev, a Russian agronomist, who suggested that economic activity could be categorized in periods of prosperity and inflation with each wave lasting 30 to 60 years. Our research indicates that another node of such a Kondratiev Wave occurred during the inflation fighting period, marked by a 16 year trading range in the Dow Jones Industrial Average which lasted from 1966 through 1982. As inflation fighting lessened toward the end of the Cold War, the stock market resumed a more evident long term up-trend in 1982 which we believe was boosted by the end of the Cold War when the economic strains on the United States of vying with the Soviet Union decreased starting about 1990. The mid-east war was a relatively minor complication, as was the aerial war in remnants of the former Balkan Countries. Post Cold War and post minor wars redirection of resources from the military to peacetime activities hampered the initial phases of what we call the post Cold War (and post minor wars) economic expansion and bull market. Our presumption is that this economic expansion with relatively low inflation may continue for many years ahead unless a war or some other unusual economic strain brings this expansionary phase of the Kondratiev wave to another node.

The Current Cross Currents

Over the last five years the Federal Reserve has been concerned that inflation would re-ignite due to wage pressures since the unemployment rate reached and remained at unusually low levels. The oft expressed concern has affected the psychology of investors, particularly causing growth oriented investors to seek stocks where the prospects appeared bright and promising even if interest rates rose such as in the new areas of the economy with lessened focus on old economy growth stocks.

There has been a Bear Market for 3 to 5 years in old economy stocks in general, including quality growth stocks and defensive growth stocks as well as many cyclical and mature stocks. In this climate, investors catered to the large cap essentially Blue Chip Growth stocks as a haven in which to preserve their wealth even if not much progress in times of appreciation took place, Aggressive investors sought out stocks of smaller, high tech companies found on the NASDAQ. Mutual fund and institutional fund managers whose jobs depended on performance joined in because there were not enough opportunities for significant appreciation in old economy stocks. As often happens, when new industries evolve, some of the primary engines of growth in the new economy became sought after and essentially took over the role of quality growth stocks. Such names as Amazon.Com, America on Line, Cisco Systems, CMGi, Ebay, Internet Capital Group, Internet Capital Group, Sun Microsystems, Oracle and Yahoo were bid up to fairly high prices. They became favorites because their broad exposure and prominent positions in fast growing parts of the new economy having outstanding growth potential. Because these companies, as a group, appear to have far more growth potential than quality growth companies of the old economy, they have been seized upon by knowledgeable investors as the premier among the new economy stocks, and are generally viewed as quality growth stocks which can be held for long periods of years for their eventual probable big payoff.

The popularity of these stocks led to excellent performance. Our own Starwood Strategic Program exceeded 38% rate of return in each of the last three years. The good performance of these stocks continued despite the campaign to raise interest rates last year and through the early part of this year. Then the psychology changed for a number of reasons, but primarily because these stocks were viewed as at least temporarily overpriced because they had performed so well and because it became clear that the Federal Reserve was concerned since economic growth continued to accelerate during the early part of the year despite its interest rate raising campaign. Investors anticipated that it would put into effect more stringent measures to slow the economy. Many investors decided to sell these new economy quality growth stocks because they feared that the more assertive efforts of the Federal Reserve might slow the economy enough to decrease the rapid growth of these favored stocks. Hence, these stocks which had long outperformed the market as judged by the Dow Jones Industrial Averages and the Standard & Poors 500, reacted suddenly and sharply. Many of such stocks declined significantly, although quite a few of the stocks in the Starwood Strategic Program remained close to their highs, and appear now to be rising toward new high prices. Also, a good portion of the new economy stocks which declined have now built bases and appear to be recovering.

As widely anticipated, the Federal Reserve did not take more assertive action in May and raised interest rates by _ of 1%. Probably, more because of the moral suasion (cautionary statements by the Federal Reserve) than because of the rise of interest rates, and perhaps because of an erratic fluctuation, some signs of slowing did show up during May and June. At the Federal Reserve meeting in late June, the Federal Reserve decided to leave interest rates as they were and made no further increases. This inaction is being widely interpreted as a sign that the Federal Reserve believes it has raised interest rates enough to achieve slowing of the pace of growth of the economy and may declare "victory" to the campaign. At any rate, inflation (other than oil prices which are erratic and affected by international politics) has remained muted and even the rate of unemployment reported last week edged up by
1/10 of 1%.

Very possibly signs of moderation of the growth of the economy may continue long enough to cause the Federal Reserve to restrain from raising interest rates at its meeting in August as well. Even if the economy resurges, inflation has remained muted, the price of oil has declined somewhat from its highs, and with the politics of national elections, it seems unlikely the Federal Reserve will be aggressive in raising interest rates much further or longer. In fact, the growing surplus, which has several times been estimated at a higher level than previously is enabling the U. S. Treasury to buy long term U. S. Government bonds. The debt of the government is dwindling and interest payments may be reduced by buying back bonds. Hence, eventually, interest rates may recede while the growth of high technology brings about further productivity gains to restrain inflation even at higher rates of growth of the economy and despite lower unemployment differently than the Federal Reserve has contemplated. Hence, even some of the stocks which have continued to decline into July may soon rebound.

We have done some considerable research on the opportunities for doing business in the new economy for the benefit of Nustar.Com which owns Associated Family Services and Starwood. It is interesting that a company called Hot Mail.Com, founded by an investment of $500,000 by venture capitalists sold 18 months later for more than $900,000,000 to America On Line. This was one of the initial instances of what has become known as viral marketing or internet referrals because the service of free e-mail was advertised by banner ads on the free e-mails sent by each customer to his or her friends and associates. This led to very rapid growth of the customer base, far faster and more effectively than has been heretofore achieved by direct marketing in the old economy. Also there are now many new firms teaching what has been discovered by the early adapter of what may be called marketing with e-mail. The results of these techniques of marketing in the new economy have been found to be far more effective than results of marketing in the old economy. We believe many of the Corporations engaged in the new economy are just now developing marketing programs based on the new techniques which are espoused by recently published books and consulting organizations. We are about to discover which companies will have their prospects greatly improved as they adopt their newly refined marketing techniques. Very possibly, many of the quality growth stocks of the new economy listed earlier will be the beneficiaries of such new techniques. A portfolio, including some of such stocks may do extremely well over time, even if there are some stocks which never make the grade if the portfolios are held patiently so that the winners are held long enough to far overshadow the losers. We have found it useful to construct such portfolios because no account executive can anticipate every shortfall, and trying to outguess all the short term moves of the market and of individual stocks leads to curtailing the great appreciation of the winners so that they can offset the losers and bring about outstanding performance of the portfolio. This is one of the techniques by which the Starwood Strategic Program has achieved the ranking in the top 1% of portfolios of money managers over the last 20 years, through 1999. Patience is not only necessary in portfolio management, it enhances the probability for long term success immeasurably over short term trading.

At this time of the year, in the year 2000, we have anticipated a changing of the investment tide, whereby new economy growth stocks will again outperform growth stocks of the old economy and some of them will exhibit extraordinarily high appreciation.

Anticipation of Market Action in the Near Future

Old economy managements are handicapped by old economy strategies and techniques. Many economists appear to classify the Federal Reserve as an old economy institution still trying the strategies and techniques that were found effective in the old economy historically. However, new economy managements armed with newer and more effective strategies and techniques are gaining advantages over the old economy corporations in industry after industry. The Federal Reserve is undoubtedly aware of the disparity but probably not yet willing to alter its strategies and techniques. It still believes that increasing interest rates to try to slow the economy to create increases in unemployment is an effective way to restrain inflation. Nevertheless, it acknowledges the role of high technology in bringing about productivity gains to restrain inflation. In this context we continue to expect erratic price fluctuations of stocks as investors judge whether the Federal Reserve will continue the old economy ways of restraining inflation. In the meantime, as time goes by and the budget surplus increases, the U. S. Treasury will redeem more bonds, thus providing liquidity to the financial markets in a way that should ultimately lower interest rates. With the politics of the national election looming, we anticipate that whatever the trend of government statistics, the Federal Reserve will feel constrained from being too aggressive in restraining the growth of the economy. It is possible that investors become sanguine about the prospects for the new economy and again focus more and more attention and dollars for investment in new economy stocks. Therefore we believe the disparity in performance between the old economy and new economy stocks may widen in favor of the most proficient of the new economy stocks. This may allow the economy to expand in a low or non-inflationary way, even perhaps with prices falling somewhat as the productivity of the new economy increases and new products and services are rolled out with greater capabilities than those replaced. We may soon be witnessing a more challenging investment climate with bountiful opportunities for appreciation a well as steep reactions where our multi-strategy approach with a primary focus on quality growth stocks may advantage us to increase the average rate of appreciation for our clients even further over the next decade than in the past two decades and rank among the top money managers in the coming decade as well.

Should you wish further elaboration of information about Starwood and the investment opportunities it provides, please call J. Stephen Anderson, toll free at (877) 354-7742.