To: Account Executives, Friends and Allies

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

Date: August 7, 2000

There continue to be many volatile movements of stocks and cross currents of changing preferences of industry groups by investors while the averages have consolidated sideways. This is not surprising because analysts and investors remain concerned that the six increases of interest rates (and a threatened seventh) by the Federal Reserve are slowing the growth of the economy and may lead to earnings disappointments for many companies. When companies report lower earnings than analysts and investors have been led to expect or suggest slowing growth, there frequently follows a sharp reaction in the price of the affected stock. However, when earnings estimates are raised or reported higher than expected, only a modest increase occurs in the price of the stock of the affected company.

Investor psychology has been greatly influenced over the last few months since Alan Greenspan, Chairman of the Federal Reserve, explained that the “wealth effect” of high stock prices was making many consumers who had stock holdings feel ebullient and contributing to faster growth of the economy than was healthy thus risking a flare up in inflation. Since then, many formerly popular stocks, especially in high technology and the internet, have declined considerably, much more than is evident in the NASDAQ average. Now there is some risk that tax loss selling during the balance of the year will further erode prices for stocks which have performed poorly.

While the economy has only given a few signals of moderating growth, the precipitous declines of many formerly popular high tech and internet stocks has certainly undermined the argument that the wealth effect is contributing to inflationary pressures. In fact, many analysts and investors consider that there have been so few signs of significant slowing in the economy that should the stock market rally before the August 22nd meeting of the Federal Reserve, enough concern about the additional stimulation from this renewed wealth effect may cause the Federal Reserve to again raise interest rates; consequently, if the stock market consolidates or declines, probably the Federal Reserve will not raise interest rates at this forthcoming meeting.

During this period of uncertainty, the investing public probably will prefer the stocks of companies where they have the greatest faith in continued above average growth, especially those exhibiting earnings rather than trading on the basis of future hopes and emphasize the stocks of larger, well established companies.

Therefore, we see a transition in leadership to some degree from the volatile group of high technology companies and away from many which have not yet establisher unreliable earnings to those with more seasoned businesses and currently good prospects. Many of these latter have consolidated over the last year or more. They seem logical investment vehicles with appreciation potential while investment professionals sort things out during this period of transition. However, when it becomes more clear what groups and individual stocks will be the primary beneficiaries of growth and appreciation, especially in the next generation technologies, propitious stocks of those categories may become the next major winners in the stock market.

A very interesting development occurred during the question and answer part of the recent testimony before Congress by Chairman Greenspan. He essentially admitted that the guidelines that the Federal Reserve has relied on over the last several years that inflation would be stimulated when unemployment declined below 5% was probably no longer as meritorious as in the more distant past. Chairman Greenspan elaborated that the economy has changed in recent years. He even concluded that the current level of 4% unemployment may not be dangerously low so as to develop wage pressures that would be inflationary largely because productivity gains are offsetting such pressures. This is significant as a sign that the policy-making strategies of the Federal Reserve may soon change! We are hopeful that the new rationale will be more favorably disposed to the interests of investors in the stock market and less likely to undermine their confidence by criticisms about “irrational exuberance.”

The post cold war (and post minor wars) bull market will probably resume its long term up-trend before the end of the year rekindled by the benefits of the growing budget surplus and a more perceptive understanding by the Federal Reserve of the invigorating benefits of an ebullient stock market in furthering high technology developments which enhance productivity. We anticipate repositioning some client accounts to protect against volatility, tax loss selling affecting underperforming stocks and redeploying capital to some of the most fortuitous stocks for appreciation in the near future.