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QUARTERLY COMMENTARY FOURTH QUARTER 2006

2006 YEAR IN REVIEW

After tepid market returns in 2005, our expectationsin the beginning of 2006 for improved returns werehopeful, yet modest. Rising short-term interest rates,high energy costs, and a softening housing market ledus to expect average returns from equities and sub-par results from fixed income. While the bond marketperformed as expected, stock prices built momentumeach quarter and produced a pleasantly surprising15.8% return.

The U.S. stock market posted solid returns in the faceof an economy that grew more slowly than in recentyears. After a firstquarter GDP measure of5.6%, each successivequarter saw GDP growthmoderate to 2.6% in thesecond quarter and 2.2%in the third. Strength inthe corporate sectordrove favorable equityresults. Corporate earnings and cash flows havegrown significantly on the heels of the 2002recession, but until recently, equity returns had not

followed in step. With consecutive years of corporateearnings strength (E) outpacing stock price growth(P), valuations as measured by P/E ratios had becomeattractive. Today, with both the Dow Industrials andS&P 500 near all-time highs, prices are morereflective of prevailing corporate earning levels,though P/E ratios are still reasonable at 17 timesearnings.

The highly anticipated bursting of the housingbubble has not materialized as dramatically asexpected. The residential housing market did soften

nationwide and inventories remain elevated, buthousing-related statistics surprised on the upside inthe fourth quarter. The slowdown is likely tocontinue, as indicated by employers in theconstruction industry shedding 20,000 jobs in theclosing months of 2006. However, non-residentialconstruction was particularly strong, posting a 14%improvement from 2005.

Foreign equity markets continued to perform duringthe year due to a combination of strong earnings

growth, currency strength, and greater exposure to

cyclical commodity-based sectors. These forces haveresulted in better performance than their U.S.counterparts for four years in a row. While small U.S.companies did outperform the larger capitalizationS&P 500 Index, much of their performance came inthe first quarter. After April 1st, small capitalizationstocks underperformed the S&P 500 by 7.1%.

THE FED VS. BOND TRADERS

The Federal Reserve increased short-term rates fourtimes in 2006, shifting rates from 4.25% to 5.25%.This led to a steeper inversion of the yield curve that

reflects the philosophicaltug-o-war between thecentral bank and bondtraders. With coreinflation currentlyrunning at 2.8%, which isabove the Fedsunofficial target level,and the unemployment

rate at only 4.5%, the Fed appears to be comfortablewith a below trend GDP growth rate. Wall Streetbond traders, feeling the Fed is ignoring the

recessionary impact of a housing market decline, arebetting the next move will need to be stimulative. Wefeel the greater risk is at the longer end of the yieldcurve and thus have been buying bonds with veryshort maturities. Our high quality and low durationbond portfolios have had better relative returns thantheir benchmarks. They are well positioned in theevent the bond traders capitulate and recognize thefocus of U.S. central bankers remains on controllinginflation.

ELECTION SURPRISES

The November elections reshaped the politicallandscape as the Democrats took control of the Houseand very narrowly won the Senate. The incomingHouse Speaker, Nancy Pelosi, has announced that shewill bring action within the first 100 hours, not thecustomary first 100 days. Traditionally, politicianswait until after the Presidents State of the UnionAddress to bring new legislation. We expectmanaged conflict between the Bush Administrationand the Democrats to result in little meaningful

Index Performance Q4 06 YTD

Dow Jones Industrials 7.37 19.03

Standard & Poors 500 6.69 15.78

EAFE (international stocks) 10.42 26.96

Russell 2000 (small stocks) 8.91 18.43

Lehman Intermediate 1.02 4.07

Lehman Municipal 1.11 4.84

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change leading up to the 2008 presidential election.The most significant impact this change in politicalcontrol will have is on tax reform. We anticipate thatwe have seen the low in both income tax and capitalgains tax rates.

SECTOR PERFORMANCETelecom and Energy proved to be the two bestperforming sectors for the year, up 32.1% and 22.2%,respectively. Consumer Discretionary, Utilities,Financials, and Materials all posted mid-teen returns.Technology was up 7.7% and Health Care, the worstperforming sector, finished up 5.8%.

During the fourth quarter we sold our positions inHome Depot (tkr: HD) and Symbion (tkr: SMBI),both for modest losses. Home Depots managementteam continues to emphasize revenue growth over

profit without asolid rationale thatwill benefitshareholders. AtSymbion, we weredisappointed thatpositive revenuetrends at itssurgery centers didnot result in profitgrowthacceleration.

Revenue sharingwith participating surgeons resulted in mutedcontributions to shareholders profits.

Late in the year we added Western Union (tkr: WU),a recent spin-off from First Data Corp. The WesternUnion brand and expansive worldwide networkprovide a unique competitive advantage enablingsignificant cash generation. There will undoubtedlybe political concerns related to immigration reformand high fees charged to typically low incomecustomers, but we would likely use associated price

weakness as an opportunity to increase our position.

Two other portfolio positions that garnered extraattention were Walgreens (tkr: WAG) and Caremark(tkr: CMX). Early in the fourth quarter, Wal-Mart(tkr: WMT) announced that it would start sellinggeneric prescriptions for $4 each. Walgreens,Caremark, and many others in the drug retailingbusiness immediately saw shares fall as much as 15%

with the entrance of the behemoth into their coremarket. Believing the markets initial reaction to beoverdone, we took the opportunity to increase ourWalgreens position and have since enjoyed arebound in the price. In November, CVS Corp. (tkr:CVS), a Walgreens competitor, announced its

intentions to merge with Caremark. Later in thequarter, ExpressScript (tkr: ESRX), a Caremarkcompetitor, made a competing offer to purchase thecompany. As a result of the competitive bidding,Caremark shares are up over 10%. We expect a dealto eventually be consummated at a price near $60 ashare, 5% above the year-end closing price.

M&A ACTIVITY LEADS TO OPTIMISM FOR 2007

The worldwide value of mergers and acquisitions(M&A) in 2006 totaled nearly $4 trillion. Privateequity firms contributed their part representing close

to 20% of all deals done inthe U.S. led by the $30.6billion buyout of HCA Inc.It is estimated that privateequity firms have $2 trillionin buying power headed into2007. This massive infusionof liquidity reflects theoptimism surrounding theability to find value intodays equity markets.

With the political stalematebetween Congress and the Bush Administration, webelieve little will happen politically that will impactthe markets. We believe the Fed will be successful inorchestrating a moderate growth trajectory for theU.S. economy. Further stabilization in the corporatesector will help offset the decline in contributionfrom consumers as the housing market extends itssoftening. A dramatic increase in householdmortgage defaults will make money more difficult tosecure, hastening the decline in housing sales prices.International markets will continue to outpace U.S.

growth but will also moderate from the growth ratesof the last few years. Our outlook is for modest fixedincome performance with returns for the yearreflected in existing yields. The stock market willbenefit from continued investment by the corporatesector and speculation from well-funded privateequity firms. This will lead to price appreciation inline with corporate earnings growth of high singledigits.

S&P Sector Performance 2006

32.13

22.21

17.23

16.87

16.16

15.73

11.76

11.02

7.70

5.78

Telecom

Energy

Cons. Discretionary

Utilities

Financials

Materials

Cons. Staples

Industrials

Technology

Health Care