Third Quarter 2007

Quarterly Review & Outlook

If one just looked at the numbers for the past quarter you would probably surmise that the equity and debt markets had an OK quarter and that returns were in the mid-range of the historical averages. In actuality, the movements of the debt and equity markets were anything but “normal”. In late July through mid August the problems in the sub-prime credit markets spilled over to the rest of the credit markets to such an extent that the availability of credit (willingness to lend) evaporated for all but the most credit worthy borrowers. From mid July to mid-August, the S&P500 dropped by more than 9%. Corporate and non-government bonds also experienced precipitous declines in value. There were genuine concerns that the “contagion” in the credit markets would spill over to the “real” economy and push us into a recession.

The Federal Reserve came to the rescue by lowering the discount rate and the Fed Funds rate by ½%. Additionally, the Fed injected unprecedented amounts of money into the economy and made it clear to the markets that the Fed would stand ready to supply additional liquidity, if necessary, to maintain order in the capital markets. The equity market reversed its decline and ended up generating a new high for the year. The debt markets also stabilized as a result of the Fed’s easing. The credit markets willingness to lend is a crucial factor necessary to generate economic growth. We have gone from an environment of “easy money” to and environment of “tighter” money. The easy money environment led to very loose lending standards and imprudence on the part of borrowers. It will take a while for the economy to work through these problems and credit problems are bound to act as a drag on the economy.

We have mentioned in previous letters our concerns about the dependence of borrowings that have been necessary in propelling the economy for the past five years. Whether it be from consumers borrowing against their home equity loans to maintain spending to large leverage buyouts providing liquidly to the equity markets, this cycle of borrow and spend has all but ended this year. We believe that the recent contraction in the credit markets has significantly raised the probability of a recession beginning sometime next year. Please bear in mind that we are not predicting a recession but that the odds of a recession have increased over the past quarter.

Recent economic statistics have confirmed that the U.S. economy has slowed down. What we don’t yet know is if the decline in credit availability and housing values will cause a decline in spending on the part of U.S. consumers. Consumers account for more than 2/3rds of our nation’s economy and any meaningful decline in purchasing will have a negative impact on economic growth.

One possible offset to the negative outlook for the U.S. economy is the vigor and health of the worldwide economy which, particularly in Asia, is continuing to boom. Will the health of the worldwide economy be enough to prevent the U.S. from entering into a recession? It’s a distinct possibility that only time will tell. We do believe that risk levels have increased slightly since the last quarter and that it is appropriate to increase the defensive component of client portfolios over the next quarter.

As always, should you have any questions concerning our outlook or your portfolio, please do not hesitate to give us a call.

Sincerely,

James A. Martin, III