n Sit/Kim International Investment Associates, Inc · Sit/Kim International Investment Associates, Inc. July 26, 1999 Investment Outlook and Strategy Page 2 Sit/Kim International

■ Sit/Kim International Investment Associates, Inc. ■

International Investment Outlook & Strategy

July 26, 1999

EXECUTIVE SUMMARY

Investment performance in international equity markets was mainly positive in the second quarter of 1999. The MSCI World Index rose 4.8%and the MSCI EAFE Index gained 2.5% in U.S. dollar terms. Asian equity markets produced the strongest returns as portfolio investmentscontinued to flow into Japan (MSCI Japan +7.6%) in anticipation of an end to the prolonged economic recession. Non-Japan Asia surged(MSCI Pacific Ex-Japan +17.2%), based on expectations of a faster expansion in economic activity than previously thought, as a result ofimproved financial conditions and greater liquidity. Most European markets rose in local currency terms. However, the MSCI Europe Indexfell 0.3% in U.S. dollar terms as the value of the euro continued its decline by 4.1% to $1.02 versus the U.S. dollar and other Europeancurrencies lost value as well. Latin American markets performed well in the second quarter, but gains were limited by the announcement inmid-May of a tighter monetary policy bias by the Federal Reserve in the U.S.

Our outlook for international equities is positive in view of the favorable inflation and interest rate environment and stronger corporate earningsgrowth based on: (1) a reacceleration of economic growth in Europe; (2) anticipation of an economic upturn in Asia; (3) a bottoming of Japan’srecession; and (4) the continuation of economic reform and corporate restructuring trends around the world as the globalization process movesforward. In Europe, the end of the conflict in Kosovo reduces uncertainty at a time when the outlook for corporate earnings growth isimproving. We are targeting a 60% weighting in Europe versus the EAFE Index weight of 69.4% in favor of greater near term opportunities inAsia (resulting from liquidity and improving economic prospects). We are overweighting Japan with a target of 26% versus the benchmarkweight of 24% and non-Japan Asia with a target of 11.6% versus 6.6%. We currently have minimal exposure in Latin America (0.5%) becauseof financial risks and political uncertainties surrounding the forthcoming presidential elections. Our residual cash position is targeted to be2.0%.

Sit/Kim International Investment Associates, Inc. July 26, 1999Investment Outlook and Strategy Page 2

■ Sit/Kim International Investment Associates, Inc. ■

International Investment Outlook & Strategy

Our economic and financial market conclusions are summarized below:

1. International equity markets should continue to perform positively as1999 progresses based on: a) European economic growth reacceleratingin combination with attractive market valuations, a positive inflation andmonetary backdrop, and long-term benefits of privatization, corporaterestructuring and the benefits of EMU; b) Asia’s increased liquidity andthe prospect of accelerating economic growth: and c) Japan’s anticipatedeconomic recovery and positive equity market supply/demand conditions.

2. The outlook for global economic growth continues to improve (seeExhibit A). We are forecasting 2.0% growth in 1999 as we expectpositive accelerating growth in Europe and improved economic growthprospects in non-Japan Asia, a bottoming of the recession in Japan, and agradual slowing of growth in the U.S. as liquidity conditions havetightened slightly. More normalized capital flows, recovering currencies,less weakness in commodities prices, and the improving growth prospectsoutside the U.S. should result in a more balanced overall growth trendthat should prove to be positive for the financial markets as both inflationand interest rates remain low.

3. European markets generally advanced in the first half of 1999 in localcurrency terms. The reduction in value of the euro should benefitexports, and in the current environment of low interest rates andestimated 9%-10% corporate earnings growth, valuations have becomeeven more attractive. We are targeting a 59.9% weighting in EAFE+accounts compared with a 58.2% actual weighting at the end of thesecond quarter and the MSCI EAFE Index weight of 69.4% (see ExhibitB).

4. A market rotation from growth to cyclical stocks that began in the firstquarter and continued in the second quarter hindered our portfolios’performance. Going forward, we see limited potential for the cyclicalgroup to advance because of our belief that a significant portion of theanticipated improvement in the earnings cycle has already beendiscounted. Our focus remains on high-quality growth companies withmarket dominance and strong earnings growth.

5. The reallocation of financial assets to Japan continues as the Nikkei 225Index recently moved above its long-term downtrend. Foreign managersappear to still underweight Japanese shares, and Japanese pensions haveonly begun to invest the fiscal year’s available equity allocation. We areincreasing our target weight to 26% from a 25.6% actual weight atquarter end versus the MSCI Index Japan Weight of 24.0%.

6. Liquidity is driving Asian markets as financial conditions improve.Brighter economic prospects are evident in both industrial production andtrade figures. Slack in the various resource markets should keep inflationlow, and interest rates remain at favorable levels. We have a targetweight in non-Japan Asia of 11.6% versus the Index weight of 6.6%based on our expectations of accelerating economic growth and risingcorporate profits.

7. The recent hike in short-term interest rates in the U.S. and fears thatrates could move higher negatively affected investor confidence inLatin America which impacted both bond and equity markets. With theexception of Mexico (0.5% weight), whose economic growth is soclosely tied to that of the U.S., we have limited exposure in LatinAmerican markets as we believe there are more attractive opportunitiesin other regional markets.


International Equity Markets Review

Global equity markets rose in the second quarter, led by strongperformance results in Asia. The MSCI World Index rose 4.8%.The U.S. market contributed positively in both the first and secondquarters (+5.5% and +6.6%, respectively). The MSCI EAFE Indexwas up 2.5% (see Exhibit C). Combined with positive first-quarterperformance results, the MSCI EAFE Index return was +4.0% forthe first half of 1999. Most European markets rose in local currencyterms. However, the overall European market declined slightly by0.3% in the second quarter in U.S. dollar terms after falling 2.4% inthe first three months for an overall first-half decline of 2.4% as theeuro fell in value to $1.02 from its initial launch value of $1.1667on January 1, 1999.

European investment performance showed wide variation amongmarkets, despite the increasing tendency to view EU countries as awhole (see Exhibit D). Most northern European countriesperformed relatively well (all in U.S. dollar terms) despite theweakening euro: Norway (+10.0%), Finland (+9.0%), Sweden(+8.2%), Germany (+5.9%), France (+3.9%), Denmark (+3.4%) andNetherlands (+2.5%). Countries in closer geographic proximity toYugoslavia and Kosovo, where an armed conflict was in progress,produced either smaller positive or negative returns. Austriadeclined 0.4%, Italy fell 6.9%, and Portugal fell 7.5%, while Spainrose 0.4%. Greece, however, rose 14.4%.

MSCI Japan rose 7.6% in U.S. dollar terms as foreign investorspurchased (net) nearly ¥800 billion of equities in June alone.Market sentiment has turned 180 degrees in the last six months. A

fundamental economic turnaround has been widely heralded incontrast to persistence of recession and the actual slow pace oftransition to the global economy as manifested by structuraleconomic reforms and corporate restructuring. The +7.6% secondquarter return followed a 12.2% gain in the first quarter bringing theJapanese market total return for the MSCI Japan Index in the firsthalf of 1999 to a respectable +20.7%.

The stellar market performer in the second quarter was non-JapanAsia where many markets were positively booming. MSCI Pacificex-Japan rose 17.2% in U.S. dollar terms after rising 7.5% in thefirst quarter. Market returns were the highest in Indonesia(+118.9%), Malaysia (+61.3%), Korea (+51.2%), Thailand(+51.1%) and Singapore (+45.1%). Australia (+5.3%) and NewZealand (-0.2%) produced the weakest returns. Except forIndonesia, nearly all the countries’ high returns were achieved aftertheir currencies had already staged strong recoveries. A completesummary of Asian market and currency performance is presented inExhibit E.

Latin American equity markets made sizeable gains in the secondquarter until mid May, when the markets peaked and began todecline in anticipation of higher interest rates in the U.S. Despitethe fact of Brazil’s devaluation of the real, which occurred inJanuary, Argentina (+16.0%), Brazil (+18.2%), Chile (+21.0%) andMexico (+55.8%) all achieved double-digit gains for the first half of1999. These results are shown in Exhibit F.


European Outlook-Key Issues and Implications for Regional Markets-

In the June quarter, European markets continued to suffer from thereallocation of assets to the Asian markets seen in the first quarter,as well as a heavy rotation into cyclical stocks from growth stocks.On a sector basis (based on the Morgan Stanley EAFE Index), thestrongest performers were building materials, chemicals, dataprocessing and reproduction, electronic components andinstruments, electrical and electronics, forest products and paper,machinery and engineering, metals, materials and commodities, andreal estate and shipping. These sector returns were in the 10%-20%range (in U.S. dollars). The two weakest sectors were insuranceand health and personal care, traditional growth stock sectors.

We are cautiously optimistic on the European markets. Weanticipate moderate market appreciation over the next 12months based on improving economic conditions, eurostabilization and attractive market valuations (see Exhibit G).We look for major market forces and issues similar to what wehave been experiencing over the last three to six months,including:

1) European and global economic outlook;2) The investor psychology impact from the resolution of

the Kosovo conflict;3) The progress of EMU countries in addressing structural

issues that will make Euroland more globallycompetitive; and

4) Ongoing rotation from European markets into Asianmarkets, particularly Japan.

Economic Outlook

We expect the “tug of war” argument over how rapidly theEuropean (as well as the global) economies are recovering tocontinue, thus impacting the desirability of the European markets,strength of the euro currency, and investment sector leadership.Unfortunately, since the beginning of the year, various Europeaneconomies had mixed growth results resulting in an overallslowdown. The euro depreciated to $1.02 from $1.167 at the time itwas launched in January (see Exhibit H). Germany, Euroland’slargest economy, has weakened (contracted 0.4% in the fourthquarter of 1998), while France has remained fairly strong andIreland and Portugal have experienced rapid growth. The weaknessin Germany is the result of the negative impact from the emergingmarkets of Asia, Europe, and Latin America, as well as weakereconomic conditions within Europe. Germany is further sufferingfrom labor union negotiations where there are demands for wageincreases of 3%-6% versus an inflation rate of less than 1%. Webelieve that the weak economy probably bottomed in the firstquarter and that going forward modest economic growth of 2%-3%in Europe, as well as on a global basis, will be achieved in 1999.This compares with the roughly 2.8% real growth experienced in1998. We do think, however, the improvement will be “choppy.”We are hopeful that in 2000, economic conditions will improvefurther and growth will be at the higher end of our 2%-3% range.With this economic improvement, we


also think the euro reached its low and should rebound to the $1.05-$1.10 range. The UK is improving faster than we thought. Weestimate that GDP growth will be roughly 0.9% in 1999 and 2.7%in 2000. This compares with our last-quarter estimate of 0.4% in1999 and 2.2% in 2000. In 1998, GDP growth in the UK grew at2.1%.

On April 8th, the European Central Bank surprisingly cut interestrates 50 basis points versus our estimated 25 basis points, and theUK cut rates 25 basis points to 5.25%. The UK cut rates another 25basis points on June 10th. These rate cuts, combined with strongconsumer confidence, should help to stimulate the Europeaneconomies (see Exhibit I). As we had anticipated, on June 30th, theU.S. Federal Reserve raised short-term interest rates 25 basis points.We view this as a preemptive strike, keeping the U.S. economy on acontrolled growth path with inflation in check. We do think,however, that the European Central Bank, as well as otherinternational central bankers, will remain open to reducing rates ifthe world economies again stumble.

European Monetary Union started smoothly and on time January 1,1999, with no technical problems. However, since the start of theyear, the euphoria of the new, united market has faded. Italyrecently received approval to deviate from the 2% GDP deficittarget for EMU members. This deviation has raised concerns aboutthe viability of EMU. We believe strongly that EMU will be viableand, in the longer term, benefit from price stability, elimination ofexchange rates, lowering of short- and long-term interest rates,opening markets, and the increasing importance of the Europeanmarketplace.

With our improving European economic outlook and our globalgrowth forecast of 2%-3%, we think earnings across Europe canincrease in the 9%-10% range in both 1999 and 2000 (see ExhibitJ). The UK should experience an improvement in earnings to offseta slowing in Continental Europe.

Resolution of the Kosovo ConflictThe resolution of the Kosovo conflict and rebuilding couldpositively impact investor psychology and comfort in investing inEurope. Up until now, the Kosovo crisis has been a “virtual non-event” in the world financial markets documented by the newmarket highs reached in the U.S. and UK. While at this time we donot anticipate any material direct negatives that would derail themarkets, we are continuing to monitor the situation closely. Withthis resolution, investor risk premium for European investmentsshould decline due to the increased stability and elimination ofuncertainty, particularly in the use of resources. Some other issuesthat we continue to monitor include political infighting amongmajor European governments and the trend in commodity prices.

Fixing EMU Country Structural ProblemsDebate on the progress of the various European countries in theEuropean Monetary Union relating to fixing structural problems,particularly unemployment and corporate taxation, will likelycontinue to impact the pace of economic and market improvement.Unemployment rates across the EMU member countries averageabout 10.6%. Spain, Italy, France, Finland,


and Germany are the highest at 17.8%, 12.3%, 11.6%, 10.7%, and9.1%, respectively (see Exhibit K). These compare with theunemployment rate in the U.S. at about 4.2%. In addition, thecorporate tax structure is high, particularly in Germany, France, andItaly (the three largest economies). As seen in Exhibit L,Germany’s rate is the highest in the 43.6%-56.7% range. Inaddition, across EMU member countries, the corporate tax structureis far from consistent. In late June, the German Finance Ministerannounced important fiscal reforms. Key measures include a DM30 billion reduction in fiscal year 2000 federal expenditures, and acorporate tax rate reduction to around 40% for the year 2001.While these are positive steps, we do not expect any quick strides instructural reforms, but rather slow, evolutionary progress.

Rotation from European Markets to Asia

Rotation from European equity markets into Asian markets,particularly Japan, started in the March quarter and accelerated inthe June quarter. The top performing markets (in U.S. dollars) wereIndonesia (+118.9%), Malaysia (+61.3%), South Korea (+51.2%),Thailand (+51.1%), Singapore (+45.1%), Taiwan (+26.2%),Philippines (+24.9%), and Hong Kong (+23.5%). The worstperforming markets were Ireland (-12.6%), Portugal (-7.5%),Belgium (-7.3%), Switzerland (-7.3), Italy (-6.9), and the UK(-1.7%). We believe that the rotation out of Europe is due toanticipated financial and economic improvements in Asia, fears of“missing out” on the recovery, and earnings concerns in Europe.

Market Valuations and SentimentBased on historical earnings and cash flow valuations, we believethat the European markets are currently undervalued. First, the

Euro-STOXX 50 Index earnings yield to bond yield ratio is now 0.8as shown in Exhibit M. Historically, as shown in Exhibit N, since1990, whenever the ratio is at more than one standard deviationaway from the seven-year moving average (as we are currently), theEuropean stocks are viewed as inexpensive and attractiveinvestments.

Second, the price/earnings multiple estimates are 24.0-25.0x for1999 and 21.5x-22.5x for 2000 (see Exhibit O). This compareswith a ten-year average of 15x-16x. However, comparing theexcess equity returns with the cost of capital shows materialincreases (see Exhibit P). This would suggest that the higher P/Emultiples are justified and valuations are attractive. Finally, asshown in Exhibit Q, earnings growth in at least the 4.0% area (ourestimate is in the 9%-10% range) and real bond yields in the 3.0%area are consistent with P/E multiples in the high 20s. This againsuggests that the market is undervalued. The expected low interestrates and inflation in European Monetary Union and other secularchanges are also supporting the argument for higher absolutemultiples than experienced in earlier cycles. Further, we believe theeconomic and euro fundamentals are sounder now than they were inthe previous two quarters, while market valuations are moreattractive.

As mentioned, there was a rapid rotation early in the June quarterinto cyclical stocks from growth stocks. In our anticipated slow-growth, low-inflation and low interest rate environment, wherecentral banks are pumping cheap money to fend off deflation, wethink history “will hold true,” leading to the outperformance ofgrowth stocks versus value stocks. We believe that the recentrotation into cyclical stocks, perhaps due to anticipated


improvement in the developing Asian markets or the cut in interestrates, is overdone.

Investment Strategy

With our 12-month outlook of improving economic conditions, astabilizing euro, and attractive equity market valuations, we arecautiously optimistic on the European markets. This optimisticoutlook is further supported by the long-term positive underlyinginvestment factors that we have discussed in earlier policy papers.These include:

1) Modest economic growth in large part due to EMU;2) Secular trends of corporate restructuring, industry

consolidations, and creation of shareholder value; and3) Increased flow of funds from privately funded

pensions/savings to offset underfunded plans and the shiftfrom lower yield bonds.

We are maintaining our European weighting in our EAFE+portfolios at about 60%. This is approximately a 14% underweightcompared with the MSCI EAFE Index. We believe thisunderweight is appropriate to take advantage of the greater nearterm opportunities unfolding in Asia and Japan. We believe therapid rotation into cyclicals from growth stocks during the monthsof March and April was overdone and that fundamentals do notsupport this huge move. Due to our modest economic growthoutlook, we have increased our weight in consumer and mediastocks and we have trimmed our positions in financial stocksslightly in favor of these purchases. We think that the financial andpharmaceutical stock prices, however, have been unfairly “beatendown” and offer attractive value when compared with their growth

rates. We are also increasing our UK exposure slightly to takeadvantage of the “soft economic landing” that now appears firmlyin place.

Our sector preferences continue to be those industries that havelong-term growth opportunities due to factors such asrestructuring/industry consolidation, aging population, andinformation technology. We believe these secular growthopportunities will provide companies with the added earningsgrowth “catalysts” in addition to being in the favorable part of theirbusiness cycles. Sectors that we are focusing on includepharmaceuticals, telecommunications (fixed line and mobile),technology, consumer nondurables, retail, and insurance.

GERMANY

We are cautiously optimistic that the German economy will supporta sustained recovery. The German economy has been the weakestlink in Euroland, having suffered the consequences of being moreexposed to developing economies than other EMU countries. Withglobal growth recovering, and the weakness in the euro, exports arebeginning to rebound; consequently, we are seeing indications ofeconomic improvement. The July Ifo (business confidence) andpurchasing mangers’ surveys also suggest a modest recovery.Business confidence improved to 74.3% in July from 56.4% inJune, the fourth straight monthly improvement. Equally importantare the government’s recent initiatives to cut corporate tax rates andfiscal spending as defined in the budget-reform package approvedby Chancellor Gerhard Schroeder’s cabinet. Consumer spending,which has stayed strong at a time when retail confidence is weak, isexpected to continue to support domestic growth as consumerconfidence remains high. Encouragingly, unemployment, though


high, did not worsen during the economic slowdown and shouldimprove as production expands in the manufacturing sector.

We are hopeful that the divergence the German economyexperienced over the past year compared with its European partnerswill soon reverse. The effects of the pickup in exports, strongdomestic demand and structural reforms will begin to be felt in thesecond half of 1999. We believe real GDP growth will acceleratetoward 2% by year end and will continue to improve in the year2000 (see Exhibit R). We sold our holdings in Fresenius andreduced the position in SAP during the quarter. We continue to bepositive on telecommunications, and we believe the financial sectorwill also benefit as the economy recovers.

FRANCE

The French economy, having ridden out the emerging markets crisismore successfully than Germany, is now slowing at a time whenGermany is showing signs of recovery. While consumer spendinghas remained exceptionally strong, buoyed by government stimulusprograms, industrial production remains depressed being hard hit bythe inventory correction under way in Euroland. The impactshould, however, be less than in the past as the French economy hasshifted to a greater focus on services and high technology in recentyears. The economy is still on target to achieve GDP growth greaterthan 2% for the year as the labor market is benefiting from thestrong construction and service sectors, an anticipated increase inforeign demand, and the positive impact of past interest rate cuts.We believe all these factors point to a pickup in GDP momentum inthe second half of the year. We made no changes to our holdings inFrance during the quarter.

GREECE

The government has reiterated that it will not relax its focus onEMU convergence despite recent election results that opposereformist moves. The ruling PASOK party lost votes to the far leftand other populist socialist groups. The loss in support for thePASOK party was largely interpreted as anti-NATO sentimentrather than a vote against reform. Acceleration of the privatizationprograms and social security reform, will likely be delayed untilafter EMU entry as a result of the elections. The ending of theKosovo conflict should change the negative sentiment as alreadyindicated by an upturn in the Greek equity market. Greece is ontarget to apply for EMU membership in the spring of 2000, havinglikely met the last EMU criterion – a reduction of the inflation rate.The May annualized CPI came in at a lower-than-expected 2.4%,implying an average inflation rate of about 2.6% for 1999,satisfying the EMU criterion by a narrow margin. However, despitethe favorable inflation environment, monetary policy will remaintight because of the fear that excess credit expansion could hinderthe disinflation trend. We have maintained our holdings in HellenicTelecommunications Organization (OTE) and Panafon. Bothcompanies are well positioned for the explosive growth in cellularpenetration occurring in Greece.ITALY

Italy’s sluggish economy shows signs of recovery after first-quartereconomic data surprised on the upside. GDP grew by 0.2% in thefirst quarter, which was very encouraging, ahead of a flat forecast.Some economists had thought that Italy was heading towardrecession, and these concerns were compounded by the recentdecision of the European Commission to allow Italy to deviate fromthe budget deficit target set at 2% of GDP for the year. A recentsurvey of large industrial firms also confirms that the manufacturing


sector is beginning to recover. May and June production estimatesshow a quarterly gain of 0.7% in the second quarter. The positivefirst quarter GDP and indications of a revival in manufacturing inthe second quarter provide reasons to believe a recovery in Italy isunderway.

The battle between Olivetti and Deutsche Telecom to acquireTelecom Italia was resolved, at least for now, with Olivetti thevictor. Olivetti was able to acquire a controlling stake in TI after amajority of shareholders tendered their shares. We believeconsolidation of the telecom sector in Europe is far from over andwill likely include TI. We also believe TI will merge with TelecomItalia Mobile in some form in the near future. We continue to holdTI and TIM, as well as Banca Fideuram, which is a pure play in thegrowing asset management business.

NETHERLANDS

The Dutch economy has slowed significantly in the past six months,but growth still is above the EU average. GDP growth in 1998 wasrecently revised upward to 4.2% with the 1999 forecast in the 2.5%area. The growth in 1998 was led by the commercial servicessector, which increased by 5%. This pace was not sustainable andthe expected slowdown is favorable for the tight labor market.Consumer confidence has been relatively stable despite an initialscare from the dioxin food contamination incident that occurred inBelgium in June. Consumer spending has been the driver ofeconomic growth and has remained strong through the first half ofthe year. The five-year low in producer confidence has not been amajor concern as manufacturing is a minor part of the economy.

We added several new holdings in the Netherlands during thequarter. ASM Lithography is a global supplier of photolithography

systems to the semiconductor industry. Equant provides seamlessinternational data network services to multinational businesses.United Pan-Europe (UPC) offers pan-European cable TV, telephoneand internet services through its own broadband communicationsnetwork. Lastly, Libertel is a provider of cellular services in theNetherlands. These recent purchases are in the high growthtelecommunications and semiconductor sectors with a global and/orpan-European presence. We continued to trim our holding inAegon during the quarter, but still have sizeable positions in bothAegon and ING.

SCANDINAVIA

Sweden, one of the first European countries to reduce interest ratesin response to the threat of global slowing when the economicproblems in emerging countries began to surface, will likely be oneof the first to raise interest rates. Sweden was quick to cut rates toprevent its own domestic economy from slowing as over 50% ofGDP is tied to exports. However, with global slowing more modestand short-lived than expected, the extent of the rate cut wasoverdone. The rate reduction occurred at a time when the telecomequipment sector was booming, a sector in which both Sweden andFinland have high exposure. The recovery in the labor-intensivedomestic sector more than compensated for the downturn inexports. With robust domestic demand, high consumer confidenceand a strong labor market, the central bank will likely increase rateslater this year to insure that the 2% maximum inflation target ismet. Meanwhile, we are expecting Norway and Denmark to reduceinterest rates during the course of the year, tightening the spreadwith EMU rates.

Our largest holdings in Scandinavia continue to be Nokia andEricsson, the two premier global wireless equipment suppliers.


Nokia provided superior performance in the second quarter. Bothcompanies are positioned to capitalize on the growing globalcellular penetration trend. Our other major holding in Finland,Tieto, announced a merger with Enator of Sweden. The mergercreated the fourth largest information technology service companyin Europe. The combined company will be known as Tietoenator.

UNITED KINGDOM

First quarter reported GDP of 0.1% was weak as expected, but theoutlook remains for an improving economy into the year 2000. Therecovery is being driven by strong domestic demand, led by a robusthousing market, and expectations are that exports to ContinentalEurope will increase as those economies improve. With the lowinterest rate environment, mortgage rates are at their lowest levelsin over 30 years. This, combined with the lowest unemploymentrate since 1980, is fueling the housing market and domestic andprivate consumption. The easy monetary policy of the last fewmonths has been directed at the strength of the pound sterling. Yet,inflation is increasingly becoming a concern with importeddeflation fading and an ever-tightening labor market. Inflationarypressures in the domestic labor and product markets are evident,implying the 18-month easing trend may be coming to an end.Monetary policy is forecast to remain steady for the remainder of1999 given the continued strength of the sterling. Thereafter, thebias is toward tightening should inflation show signs of picking up.

We continued to add to our UK holdings during the second quarterby increasing our exposure to companies that will benefit fromimproving economic fundamentals in the UK as well as having aglobal presence. We added initial positions in Pearson (media/publishing), Granada (media/hotels), Carlton Communications

(media/cable), and Compass Group (food service). We reduced ourposition in pharmaceutical company SmithKline Beecham duringthe quarter. We are retaining our position in the Swedishpharmaceutical company Astra, which became AstraZeneca afterthe Astra merger with Zeneca and established their corporateheadquarters in the UK.

SPAIN

Gross Domestic Product growth of 3.2% in Spain in 1999 isexpected to be well above the EU average. The higher growth isneeded to achieve Spain’s longer term strategy designed to bring itsaverage living standard in line with other EU members (currently at80% of EU average GDP per capita). In line with this highergrowth rate, the country has been the leader in new job creation inEU, in an effort to reduce western Europe’s highest unemploymentrate of 17.8%. The target is to increase employment by 1.2 millionover the next four years by implementing measures aimed at easingrigid labor market rules. The government also took precautionaryaction to head off inflationary pressures during the quarter afterconsumer prices moved back over 2% by implementing a widerange of measures from tackling competitive barriers to cuts inregulated utility prices. The main concern is a surge in serviceprices, especially related to tourism. Low inflation and GDPgrowth in excess of 3% are both needed to achieve living standardand job growth objectives, as well as to balance the budget by 2002.

We made no changes in our Spanish holdings during the quarter.Telefonica continues to be our largest holding in Spain and PortugalTelecom is our only holding in Portugal.


Asia Pacific Outlook-Key Issues and Implications for Regional Markets-

Bullish investor sentiment combined with a surge in liquidity ledthe Asian stock markets higher once again in the second quarter of1999. Higher export and GDP growth, evidence of corporaterestructuring and continued implementation of financial reformmeasures led more and more investors to conclude that the worst ofthe crisis has passed and that the Asian economies are rebounding(see Exhibit S). Positive economic news in Japan further fueled therally in the Asian markets, and strengthening demand in Japancontributed to increased export growth in the rest of the region.

Both Japan and Asia ex-Japan are now overweighted versus theMSCI EAFE benchmark in the Sit/Kim EAFE+ portfolios,reflecting our optimism toward sustained economic recovery in theregion (see Exhibits T and U). In response to the improvingeconomic conditions, we added exposure to a number of localbanks in Japan, Singapore and Thailand during the second quarter.This constituted a moderate diversification away from the export-oriented bias we had adopted during the depths of the economicdownturn. However, we remain wary of the fact that liquidity-driven rallies, of the kind Asia has seen in recent months, can bevulnerable to sudden shifts in sentiment. We believe our stockselection in the banking sector is geared toward the fundamentallyrobust market leaders with the strongest balance sheets rather thansmaller-capitalization "turnaround" stocks. Furthermore, in general,companies in our portfolio exhibit a greater regional diversificationof earnings and a greater participation in high value-addedbusinesses than is typical for the region. And, while we do believethat economic prospects for Asia have brightened, to mitigatedownside risk we are continuing to avoid investment in Malaysia,

due to its restrictive capital controls; and Indonesia, where thepolitical situation remains volatile.

RMB Devaluation?In China, falling export growth and foreign domestic investment(FDI) inflows (January-May exports and FDI fell -5.3% and -6.6%year over year, respectively), combined with deflation (CPI dropped-2.2% year over year in May) and weak domestic demand, again ledmany observers to predict that a devaluation in the RMB isinevitable. Theoretically, a devaluation of the Chinese currencywould provide a boost for the economy: the problem of excesscapacity would be solved as a cheaper currency results in improvedexport demand and consumers in China switched away fromimports toward domestically produced goods. FDI inflows wouldincrease as investments in China became cheaper. However, wethink it is unlikely that a devaluation will occur for several reasons.In addition to the fact that China has a large positive position inforeign exchange reserves and a closed capital account, 1999 is the50th anniversary of the Communist regime in China. This will be ayear of celebration of the success of Communism in China and thegovernment is unlikely to mar the celebration by devaluing China’scurrency. China will also be finalizing laws on property ownershipduring the next twelve months. This change in the law is likely tospur an increase in home ownership in China and, with it, anincrease in domestic demand as new property owners upgrade theirproperties.

Recent moves by Beijing suggest that the government is insteadchoosing to reflate the economy through monetary loosening ratherthan a currency devaluation. The government recently tightened


even further its restrictions on RMB circulation by prohibitingconversion of RMB at overseas banks, and then followed this with acut in the official RMB loan and deposit interest rates. Chinawields US$145 billion in foreign exchange reserves, enjoys a closedcapital account, and so far this year has seen a doubling of itsgovernment budget surplus to US$7.6 billion. We expect nochange in the RMB exchange rate to occur while the PRC iscelebrating its 50th anniversary and while the WTO negotiations aregoing on.

Internet in AsiaAs the Internet stock euphoria in the U.S. stock market hasextended to the rest of the world, the relatively few companies withinternet-related businesses in Asia ex-Japan have seen a speculativerally in their shares. We acknowledge that the growth of theinternet is indeed an inexorable trend with tremendous historicalsignificance. However, in many ways the current rally in ISP(internet service provider) and "portal" shares appears to be aclassic speculative bubble, and even if the most optimisticexpectations of earnings growth are achieved, current valuations aremuch too high to justify the two to three year holding period wetypically assign to stocks in our EAFE+ portfolios.

Nevertheless, some of our core portfolio holdings are wellpositioned to benefit from internet expansion, and these companiesalso enjoy solid profit-generating businesses. Singaporean contractmanufacturers Venture Manufacturing and Natsteel Electronics areexperiencing higher-than-expected revenue growth this year, thanksin part to a surge in demand for PCs and servers as global internetusage has increased. These stocks contributed very positively toEAFE+ portfolio performance in the second quarter. Similar forceshave contributed to a tightening of the global semiconductorfoundry capacity, which has improved our position in theTaiwanese foundry TSMC. The next year could present

considerable opportunities for semiconductor firms in both the logicand memory sectors as a shift toward broadband internetconnections, combined with widespread under investment insemiconductor fab capacity (worldwide sales of semiconductorequipment have shrunk year over year for 12 months straight), havethe potential to swing the global supply-demand balance in favor ofsemiconductor makers such as TSMC and Samsung Electronics.

Japan The second quarter was marked by strong equity marketperformance (+11.8% local, +9.4% in U.S. dollar terms), whichpaused only briefly in May as the slew of corporate restructuringannouncements from the previous quarter was digested. The majordrivers were several fold:

1) First Quarter GDP Growth

The GDP figures for the first quarter of 1999 (4Q fiscal year1998) were surprisingly strong (see Exhibit V). Japan’slethargic economy rose 1.9% quarter over quarter (7.9%annualized), comprised of +10.3% in public works spending,+2.5% in corporate capital spending, +1.2% in housinginvestment and +1.2% in private consumption. Confoundingthe skeptics, the data defied the existing trends of risingunemployment and savings rates, which have inversely affectedpersonal spending throughout the recession, as well as targets ofreduced capital expenditures (capex) plans.

2) June Tankan Report

The quarterly business sentiment survey conducted by the Bankof Japan showed an improvement over the March survey, withcontinued improvement in sentiment projected in September


(see Exhibit W). Unlike the GDP numbers, the improvedsurvey results were widely anticipated and discounted in theequity prices well before the release of the actual figures.Although the survey as a whole was an improvement, the reportwas still weak enough to suggest that supportive governmentpolicies would continue.

3) Foreign Sentiment and Asset Allocation

Investment sentiment is clearly favoring Japan, with any andevery sign of an economic recovery (real or perceived) beingused as a catalyst for pushing equity prices higher. Every issueis, for the time being, taken as a positive:

a) Capital spending reduction (a target of –25%this year by manufacturers), though a short-termnegative for the economy, is being viewed as along-term positive as Japan reduces systemicovercapacity.

b) Unemployment (peak of 4.8% in April): theheadcount reduction is part of the restructuringeffort.

c) Rising JGB bond yields (from a low of 1.2% tocurrent rate of 1.8%): a sign that the economy isimproving, with desirable inflation; small capstocks are outperforming as they are correlatedwith rising bond yields.

d) Little risk of political instability: elections, ifcalled, should easily reconfirm Prime MinisterObuchi’s tenure for two more years, given theimprovement in the equity market. Cold pizzais not so bad when heated up! (Obuchi was oncedescribed as being as exciting as “cold pizza.”)

International investors, long underweight Japan, are increasingallocations to the region as Europe’s economies have slowed. Theincreased exposure is undeniably a reduction in the underweight forall, a move to a market weight for many, and in some cases, a moveto an overweight position.

To a lesser degree, albeit still very important in the total landscape,were the following additional forces:

1) Bank of Japan’s currency intervention policy: a weak yen isdesirable for the exporters, and easy monetary policy (“zerointerest rates”) is as much a deflation-fighting tool as it isinflation-inducing.

2) Another supplemental budget is all but official for the secondhalf of the year. Minister of Economic Planning AgencySakaiya announced that additional public spending will benecessary this year to boost public investment and prevent theeconomy from faltering.

This continued activist policy helped to alleviate the most importantfear in this market: that of government complacency; a falseperception that the economy is well on its way to self-sustainingrestructuring and recovery.

The fear of a weak economy is all but discounted. Furthermore,however, there is the concern that too much potential good newshas been discounted as well. Current investment sentiment isclearly in favor of Japan. Cyclical and economically-sensitive stocksectors have been the top performers year to date, with stock pricesdiscounting an earnings recovery several years into the future.


Several notable industry trends became apparent this quarter:

1) Telecommunications: Japanese telecommunications assets werere-rated as their attractiveness on a global basis becameapparent. Direct strategic investments by British Tel and AT&Tin Japan Telecom, as well as Cable & Wireless’ investment inIDC, prompted a surge in this sector’s stocks.

3) Semiconductors: Consolidation and outsourcing continued asthe large electronics manufacturers merged operations (NEC &Hitachi), outsourced production (Toshiba), or prepared to exitunprofitable businesses (Mitsubishi).

3) Housing/Construction: Driven by government guarantees onhousing loans, combined with favorable tax legislation onmortgage payments, housing and construction orders have beenincreasing at a year-over-year rate of 30%.

We have taken a constructive view on the equity market with anoverweighted position in Japan. However, we share all theconcerns about continued systemic risks, and we are keeping a verywatchful on eye on the sustainability of this recent strength in theequity market (see Exhibit X). Prime Minister Ubuchi and FinanceMinister Miyazawa have pointed out that the Japanese economy isnot as strong as some of the latest figures would indicate. Diligenceis still required and, at this time, complacency is this market’sgreatest risk. Improving business sentiment surveys, if notaccompanied by actual improvement in results, could indicate yetanother of Japan’s many false starts this decade.

Despite the recent strength in the equity performance of companiesin the cyclical industries, we think the long-term beneficiaries are inJapan’s service economy. Our portfolios continue to emphasize thequality growth names in the sectors that are experiencing top-line

growth and those that should benefit in a restructuring environment.Representative core holdings include NTT and NTT DoCoMo inthe telecommunications sector, which have recently performed quitestrongly; Shohkoh Fund and Orix in the non-bank financial sector;and NTT Data and Nihon Unisys in the systemsintegration/computer outsourcing software sector.

Hong Kong/China Although Hong Kong's 3.4% year-over-year real GDP contractionin the first quarter and continuing export and retail sales declinesindicate that the economy remains weak, there are some signs thatconditions are beginning to improve. Stronger-than-expecteddemand at recent government land auctions provided evidence thatthe property market is rebounding, the slowing rate of decline inretail sales (-10% in April, compared to -21% in January), and an11% pickup in tourist arrivals in April suggest that the worst of theslowdown has passed. Our holdings in this market remain the sameas last quarter, and we are maintaining our neutral weighting.

China's strident reaction to the accidental bombing of the Chineseembassy in Yugoslavia by U.S. warplanes has temporarily knockednegotiations for china’s entry into the World Trade Organization(WTO) off course, and outrage on the U.S. side over allegations oflong-standing nuclear espionage in this country by the Chinese hasexacerbated the situation. However, although negotiations havebeen derailed for the moment, we continue to believe that thearguments for China's entry into the WTO are compelling for bothsides, and that an agreement will ultimately be reached, albeit at aslower pace than we had originally anticipated.

The recent rhetoric emanating from Washington and Beijingconcerning these issues probably says more about the politicalsituation within each country than it does about the two


governments' true beliefs on the subject. Whether or not they reallybelieve the attack was deliberate, the PRC leaders shrewdlyexploited the embassy bombing for their own ends. In the 80th-anniversary year of the "May 4th Movement," the bombingprovided the government with a well-timed opportunity to invokethe spirit of May 4th by supporting the demonstrations outside theU.S. embassy in Beijing, thus conveniently channeling the public'sprotesting impulses against the U.S. and away from reprise of the1989 pro-democracy movement. The government also effectivelydistracted the public from the domestic economic slowdown byfanning nationalistic fury over the incident. Furthermore, bytrumpeting its anger over the bombing and demanding an apology,the PRC government immediately put the U.S. on the defensive,which probably will provide China with some incremental leveragewhen WTO negotiations do resume.

Meanwhile, given the ubiquity of international espionage, theprofessed shock and outrage on the part of U.S. politicians at therecent revelations of Chinese spying seem disingenuous--perhaps anattempt to win points among voters before a big election year byappearing tough on China. U.S. complaints to China ultimately willnot accomplish much; probably the most important outcome of thediscovery of China's spying activities in the U.S. will be animprovement of the U.S. government’s own security controls at keyintelligence sites.

Taiwan The Taiwan stock market rallied 26.2% during the second quarter.The electronics sector posted particularly strong gains on the backof robust monthly sales figures. GDP growth for the first quartercame in at a higher-than-expected 4.3%, and a recovery in exportgrowth (May exports rose 13.7% year over year) helped raise thecurrent account surplus to US$5.4 billion during January-May.

This improved balance-of-payments situation is positive for thestock market as inflows of foreign currencies, some of which hasbeen invested into the market, have helped boost domestic liquidity.

We continue to be bullish on selected consumer and electronicssector stocks in Taiwan, and we maintain a position in this non-index market. Our addition to the portfolio during the quarter wasTSMC, the world's largest semiconductor foundry, which webelieve will be a beneficiary of the trend toward outsourcing offront-end semiconductor manufacturing and of tightening fabcapacity worldwide. As we mentioned last quarter, we are applyingfor local investment facilities in Taiwan for all our EAFE+accounts. These local facilities will open up the entire stock marketto these accounts, which now are limited to investing in therelatively illiquid GDR and ADR markets.

Tensions between Taiwan and China have flared once again in thewake of the Taiwan government’s shift away from a “one China”policy toward one characterizing cross-strait relations as “a specialstate-to-state relationship”. The PRC government’s sensitivity tothe national sovereignty issue is genuine, not only because of itsperception of Taiwan as a renegade Chinese province, but also dueto the practical reality that any acceptance of a move towardTaiwanese independence could undermine its authority byencouraging the separatist movements in Xinjiang and Tibet. Weexpect continued denunciations of the new Taiwan policy andpossibly even a fresh round of military exercises in the TaiwanStrait by the PRC in the coming weeks. However, we also believethat neither side desires a military conflict and that ultimately adiplomatic solution will be reached. For this reason, we view theshort-term volatility in the Taiwan market as a long-term buyingopportunity.


Singapore Real evidence of an upturn in the Singapore economy has appearedin recent months: GDP grew by 1.2% in the first quarter of 1999after two quarters of decline, exports and industrial output bothposted double-digit year-over-year increases in May and housingprices have rebounded from their lows of last year. As part of itsongoing effort to improve Singapore's competitiveness, thegovernment recently announced financial sector reform measures,including the issuance of new licenses to foreign banks and theremoval of the 40% foreign-share ownership limit for local banks.Senior government officials have also made public statementscalling upon the local banks to become more efficient, possibly bymerging.

We have recently diversified our holdings in Singapore to includethe Development Bank of Singapore (DBS), the largest local bank.The peaking of nonperforming loans, a pickup in the ASEANeconomies and the potential for liquidity-driven rallies all shouldbenefit the stock. The bank also appears well positioned to thrive inthe upcoming era of increased competition in the financial sector.More than other Singaporean banks, DBS, led by John Olds(previously of JP Morgan), has embraced reform and is reshapingits culture to become more focused on profit and customer service.This, combined with its large branch network and strong financialresources, bodes well for future earnings growth.

Thailand On anticipation of an economic recovery, the Thai market surged51.1% during the second quarter after falling 3.4% in the firstquarter. Exports increased 6.2% in May, after rising 4.7% in April(both on a year-over-year basis). June CPI fell 1.2% year-over-yearbecause of a cut in a value-added tax and recovery in agriculture.

First quarter real GDP grew 0.9% year over year, driven by arecovery in the manufacturing sector.

Nine of eleven economic reform bills have passed, and the remainingtwo bills are currently being discussed in parliament. There iscontinued improvement in the financial sector as nonperforming loansfell 3.8% in April, the first decline since July 1997. Interest rates alsoare continuing to decline. The government has revised the 1999 GDPforecast upward to 1%-1.2%, in line with our expectations of +1.2%.Our holdings include Advanced Info Services and Bangkok Bank,companies, that will benefit from an economic recovery.

Malaysia The Malaysian market rose 61.3% in U.S. dollar terms during thesecond quarter, reversing its 14.2% drop in the first quarter.Improving economic conditions, speculation that capital controlswill be lifted, and the potential for re-admittance into the MSCIindices all contributed to the advance. April exports grew 12.8%year over year in U.S. dollar terms, the strongest performance sinceMay 1996. M1 increased 2% year over year in April, its firstpositive growth in more than a year. Industrial productionincreased 5.4% year over year in May, and GDP forecasts are for1% growth in 1999 versus a decline of 7.5% in 1998. Malaysianow has a current account surplus and its improving economicconditions have resulted in the successful completion of financingthrough a bond issue. Its U.S.$1 billion issue of ten-year globalbonds was made at 330 basis points over comparable-maturity U.S.Treasuries.

There continues to be speculation about a lifting of capital controls andMalaysia’s eventual re-inclusion into the MSCI indices. Malaysia’sone-year lock-up on foreign investors without paying capital gainstaxes expires on September 1, 1999. Currently, Malaysia will only be


included in the IFC index beginning November. We remain uninvestedin this market because of the capital controls.

Philippines The Philippine stock market rose 24.9% in U.S. dollar terms duringthe second quarter and is up 28.8% for the first six months of 1999.The strong market performance was driven by a continued easing ofmonetary policy and an improving economy. Interest ratescontinued to decline, and the 91-day T-bill is at a 12-year low.Driven by a recovery in the agricultural sector (20% of GDP), GDPgrowth of 1.2% in the first quarter was above expectations. Theindustrial sector has improved, shrinking just 1.9% in the firstquarter versus a 4.7% contraction in the fourth quarter of 1998.Stronger economic growth is expected because of the government’sfiscal package, which is to be spent primarily on rural infrastructureprojects. We expect GDP growth of 2% in 1999 versus. acontraction of 0.5% in 1998. We remain invested in ManilaElectric Company, the country’s electricity distributor in theEAFE+ accounts.

Indonesia The Indonesian stock market is the best-performing market year todate, up 98.5%. It surged 118.9% in U.S. dollar terms during thesecond quarter based on better-than-expected economic figures andpeaceful parliamentary elections. Preliminary second quarter GDPgrowth was 1.8% year over year, and GDP growth for 1999 hasbeen revised upward to -3% from -5%. Interest rates have declinedas the 1-month SBI rates have fallen from a peak of 70% in August1998 to 23% currently, and the currency has strengthened year todate.

Our concerns remain regarding the economy, political uncertaintiesand market valuation. The economy has bottomed, but the

sustainability of the recovery is suspect since bank and debt-restructuring programs have been slow. Indonesia’s first freeparliamentary elections in 44 years appeared to go smoothly. Of 48eligible parties, Sukarnoputri Megawati’s PDI party with its “anti-Suharto” platform, continues to lead in the unofficial vote countwith about 34% of the vote. The final vote count won’t be availableuntil late July and a coalition is likely to emerge rather than a singleclear winner. The new legislative body will elect a President inNovember. We continue to avoid the market.

Korea Leading all other Asian neighbors, Korea's first-half economicrecovery has turned out to be steeply V-shaped, real GDP rising6.3% and expected to accelerate to 7.2% in the second half of theyear. The economy could expand up to 5.0% in the year 2000. Thestimulative effect of lower interest rates should contribute to full-year 1999 GDP growth to exceed 6.5%, compared with a decline of5.5% in 1998. The primary engine of growth is shifting from theexport sector to the solid strength now displayed by privatedomestic consumption. As a result, producers are rapidly buildingup inventory much sooner than previously expected. Theunemployment rate fell to 6.5% in May from 8.5% at the beginningof the year. With the Bank of Korea reluctant to ease monetarypolicy further, the government will become more dependent onfiscal instruments to maintain economic recovery. But the budgetdeficit promises to be contained by additional privatization of state-owned companies and tax receipts that are boosted by the faster-than-expected economic recovery.

Reflecting the government's explicit policy to keep interest rateslow, the yield on three-year corporate bonds has declined below the8% level, down sharply from a peak of 25% in 1998. In line withthe downward stabilization of the Japanese yen at 122 versus the


U.S. dollar, the KRW/U.S.$ exchange rate should remain at the1,150-1,200 won level for the remainder 1999. While inflationarypressures are dormant, the Bank of Korea could respond by raisingofficial interest rates in late 1999.

The current stock price level is hardly justifiable even with theexpected improvement in corporate earnings in the first half of theyear. Downside risks include the danger of "reform fatigue" andexternal hazards such as a hard economic landing in the U.S. or apolicy-induced sharp depreciation of the Japanese yen. Internally,the biggest obstacle is the delay in the restructuring of the country'sheavily indebted chaebol, holding back Korea's broadly-basedeconomic reform. Mandating a debt/equity ratio of 200% by theend of 1999, the government is set to push creditor banks toaccelerate debt-to-equity swaps and debt rescheduling. The long-term capital investment outlook is clouded by the failure of mostlarge conglomerates to accomplish downsizing and reduction ofovercapacity. Corporate restructuring efforts took a big stepforward with Samsung Motors' application for court receivership.This was the first time one of the five big chaebol has agreed toclose a large-scale prestige business. Samsung Group's chairman isdonating $2.4 billion worth of his own stake in Samsung Life tohelp pay the car unit's $3.7 billion debts. Meanwhile, Daewoo willnow sell its electronics unit to foreign investors, instead of toSamsung Electronics.

In U.S. dollar terms, the Korean Stock Exchange Index rose 63.3%(57.0% local gain plus 3.9% currency appreciation) in the first sixmonths of 1999. Money may well keep pouring into equity-typefunds over the near term, fueled by low interest rates as well as thecorporate desire to increase capital gains. Yields on bondbeneficiary certificates have fallen to the 8.0% area and domesticinvestor expectations are that interest rates could fall further.

Moreover, the KRW7 trillion in new rights issues in June wasquickly absorbed. The market exceeded the 1,000 mark, spurred bycontinued ample liquidity in the system and investment trustcompanies' demand for equities. International investor expectationsare that listed firms' earnings results for the second half of 1999 willimprove. In our EAFE+ accounts’ Korean portfolio, SamsungElectronics accounts for about 1.5% to 2.0% of the total assets.Other specialist mandates include Korea Electric Power, KoreaTelecom and SK Telecom. Our investment strategy is cautiousgiven stretched valuations caused by the liquidity-driven rally.However, we are considering the addition of a financial-sector stockas the banking sector completes its recapitalization program and theoutlook for nonperforming loans continues to improve.

Australia/New Zealand Real GDP growth is beginning to show signs of moderating thisyear after the robust growth led by consumer spending in 1998.Household spending is unlikely to outstrip income growth in 1999as consumers begin to rebuild savings. The economy is benefitingfrom rising exports to Asia, particularly to major trading partnersJapan and Korea. Economic growth is expected to be greater than3.5% again this year as Australia reaps the rewards of a decade ofstructural reforms. Despite the strong economic growth, there areno signs of inflationary pressures. The goods and service tax(GST), to be implemented in July 2000, will have a temporarynegative impact on inflation, but this should not prompt a rise ininterest rates. Interest rates are expected to remain steady for thenext several quarters as there is no wage pressure andunemployment remains high. We made no changes to ourAustralian holdings during the second quarter. We remain positiveon our telecommunications holdings despite the rotation fromgrowth stocks into the Australian resource sector during the quarter.


Clear indications of an economic recovery are being seen in NewZealand, led by consumer spending. Exports are also improving inresponse to stronger Asian demand and continued global growth.Business investments, in turn, are recovering modestly, reflectinghigher rates of utilization and inventory rebuilding. As withAustralia, cost and wage pressures are subdued, implying that thecentral bank will hold interest rates steady. We maintained ourposition in Telecom New Zealand during the quarter.


Latin American Outlook-Key Issues and Implications for Regional Markets-

The Latin American equity markets performed well in the secondquarter as currencies remained relatively stable. Argentina rose18.2% and Mexico gained 20.9%; Brazil (+6.5%) and Chile(+8.0%) produced smaller gains. (All returns are stated in U.S.dollar terms). However, the mid-May signal by U.S. FederalReserve Chairman Alan Greenspan of an increase in short-terminterest rates, which occurred June 30th, served as a brake on themarket advances.

The regional weakness in economic activity continues, particularlyin Argentina, even as interest rates have fallen (see Exhibit Y).Deep structural problems also remain. The region remains highlydependent on foreign capital for investment and debt financing,which requires both currency and interest rate stability to stay put.High levels of debt have to be financed so that access to theinternational debt markets is crucial and is greatly influenced byinterest rate trends in the U.S. Latin American countries are mainlyproducers of worldwide commodities whose prices, except for oil,remain depressed. We are cautious on investment prospects inLatin America except for Mexico.

Mexico, whose economy is strongly tied to that of the U.S. viaNAFTA, continues to benefit from the strong growth in the U.S.economy as well as the rebound in oil prices (up 70% from the lowreached in December 1998). In contrast to other Latin Americancountries where corporate earnings growth will be negative or in thesingle digits, we expect earnings growth in Mexico to be 20%

or higher in 1999 and 2000. In addition, the Mexican governmenthas secured $23.7 billion in financing commitments frominternational lenders to cover financing needs running up to thepresidential elections.

Latin American countries continue to experience politicaluncertainties. Argentina, Chile, Peru and Mexico all will holdpresidential elections in the coming year, and confidence in politicalleaders is being rattled by continuing economic and financialproblems.

Except for a position we have established in Telefonos de Mexico,we remain uninvested in Latin America in EAFE+ accounts.

ARGENTINA

The Argentine market advanced 18.2% during the second quarterbecause of the sale of the oil and gas company YPF (+20% in thesecond quarter) to the Spanish company Repsol. YPF is the secondlargest stock in the Argentine index (12%) and its sale will result ina reallocation of funds.

The Argentine recession is deepening. Real GDP shrank 3% in thefirst quarter, worse than expectations, and industrial production fell12.9% year over year in May. An additional risk is the possibilityof an end to currency convertibility in Argentina as Presidentialcandidates have stated they will not honor the currency’s eight-yearpeg. We remain uninvested in the Argentina market in the EAFE+accounts.


BRAZIL

The equity market in Brazil rose 6.5% in the second quarter in U.S.dollar terms and is up 18.2% year to date on continued interest ratecuts and less economic weakness than expected. We remaincautious and are uninvested in Brazil in the EAFE+ accounts. Ourconcerns are Brazil’s recession, its ability to cut the budget deficitand political infighting, which is stalling budget reforms.

Interest rates have declined to 21%, down from a peak of 56%. TheCPI fell 0.4% in May and the first quarter GDP’s contraction wasonly 1%. We have revised our forecast for 1999 GDP to -1.5%from -3.5%. The government has reached an agreement with theInternational Monetary Fund on primary fiscal surplus targets (3.1%of GDP in 1999, 3.25% in 2000 and 3.35% in 2001), but there arecontinued challenges within the government to the financialtransaction tax, social security spending and successfulimplementation of government spending cuts. The social securitydeficit amounted to R3.3billion in the January-May period, morethan twice its size in the similar period last year. However, theBrazilian currency has stabilized at R1.77 and is only 1.5% weakerthan it was at the end of the first quarter.

CHILE

Chile’s economy remains in a recession. The economy declined 6%in April year over year and has contracted for seven straightmonths. The government continues an expansionary monetarypolicy, and overnight interest rates have been cut by 900 basispoints since last fall to the current 5%.

An improving outlook for copper prices (+5% from their 52-weeklows) and economic growth in Asia should benefit Chile’s

economy. We estimate positive GDP growth for 1999 at 0.5% andfor 2000 at 4%. We are uninvested in the Chilean market.

MEXICO

The Mexican market was up 20.9% during the second quarter 1999and is up 55.8% year to date, the best-performing market in LatinAmerica. Mexico continues to decouple from the rest of LatinAmerica based on strong economic fundamentals, benefits fromrebounding oil prices and strong ties to the U.S. economy viaNAFTA. GDP growth was 1.9% year over year in the first quarter,with full-year GDP growth expected to be near 3%. The expectedinflation rate of about 15% in 1999 will be the lowest since the1994 currency devaluation and the unemployment rate has fallen to2.4% during May versus. 2.7% in April.

The Mexican government has obtained $23.7 billion in financingcommitments through the end of 2001 from internationalorganizations to calm investors ahead of next year’s presidentialelections. Moody’s upgraded its rating outlook to stable fromnegative for Mexico’s Ba2 country ceiling for foreign-currencybonds and notes.

We have added Telefonos de Mexico, the country’s dominanttelecommunications operator, to our EAFE+ accounts.

This analysis contains collective options of our analysts and portfoliomanagers, and is provided for informational purposes only. While theinformation is deemed accurate at the time of writing, such informationis subject to change at any time without notice.

Exhibit A��Sit/Kim International Investment Associates, Inc. �

World Economic outlook is Improving

Source: Investors Business Daily, June 21, 1999.

Exhibit B��Sit/Kim International Investment Associates, Inc. �

Sit/Kim EAFE+ Representative PortfolioCountry Allocation

1Based on EAFE+ Representative Portfolio.2Morgan Stanley Capital International , 6/30/99.

Austria 0.0 % 0.0 % 0.3 % Argentina 0.0 % 0.0 % 0.0 %Hong Kong 2.8 % 2.7 % 2.5 % Belgium 0.6 0.6 1.3 Brazil 0.0 0.0 0.0Japan 25.6 26.0 24.0 Finland 5.7 5.5 1.9 Chile 0.0 0.0 0.0South Korea 2.1 2.0 0.0 France 6.9 6.9 9.7 Mexico 0.5 0.5 0.0Singapore 1.7 1.6 1.0 Germany 5.2 6.1 9.9Taiwan 1.5 1.1 0.0 Ireland 3.6 3.8 0.5 South Africa 0.0 % 0.0 % 0.0 %

Italy 3.8 3.7 4.5 TOTAL 0.5 0.5 0.0India 0.0 % 0.0 % 0.0 % Netherlands 8.0 7.7 5.7Indonesia 0.0 0.0 0.0 Portugal 0.7 0.7 0.4Malaysia 0.0 0.0 0.0 Spain 5.0 5.2 3.0Philippines 0.6 1.0 0.0Thailand 1.2 1.2 0.0 Denmark 0.0 % 0.0 0.4 %

Norway 0.0 0.0 0.4Australia 2.4 % 1.6 % 2.9 % Greece 0.7 0.7 0.0New Zealand 0.4 0.4 0.2 Sweden 2.0 2.0 2.3

Switzerland 4.6 4.9 6.8U.K. 11.4 12.1 22.3 CASH 3.0% 2.0% 0.0%

EQUITY 97.0% 98.0% 0.0%TOTAL 38.3 % 37.6 % 30.6 % TOTAL 58.2 % 59.9 % 69.4 % TOTAL 100.0% 100.0% 100.0%

INDEX2ACTUAL1 TARGET

EUROPE

ACTUAL1 TARGET INDEX2


LATIN AMERICA & OTHERS


CASH AND TOTAL

6/30/99 9/30/99 EAFE SKI Weights

6/30/99 9/30/99 EAFE SKI Weights

ASIA PACIFIC

6/30/99 9/30/99 EAFE SKI Weights SKI Weights

6/30/99 9/30/99 EAFE

Exhibit C��Sit/Kim International Investment Associates, Inc.��

International Market Index Performance

Source: Morgan Stanley Capital International, June 30, 1999.

MSCI MSCI PACIFIC MSCI MSCI MSCI MSCI PACIFIC JAPAN EX JAPAN EUROPE EAFE US WORLD

First Half 1999 21.8 % 20.7 % 26.0 % (2.4)% 4.0 % 12.5 % 8.5 %1st Quarter 1999 11.2 % 12.2 % 7.5 % (2.1)% 1.4 % 5.5 % 3.6 %2nd Quarter 1999 9.6 % 7.6 % 17.2 % (0.3)% 2.5 % 6.6 % 4.8 %

1998 2.4 % 5.0 % (8.2)% 28.5 % 20.0 % 30.1 % 24.3 %1997 (25.5)% (23.7)% (31.0)% 23.8 % 1.8 % 33.4 % 15.8 %1996 (8.6)% (15.5)% 20.5 % 21.1 % 6.0 % 23.2 % 13.5 %1995 2.8 % 0.7 % 13.0 % 21.6 % 11.2 % 37.1 % 20.7 %1994 12.8 % 21.4 % (14.3)% 2.3 % 7.8 % 1.1 % 5.1 %1993 35.7 % 25.5 % 79.8 % 29.3 % 32.6 % 9.1 % 22.5 %1992 (18.4)% (21.5)% 6.5 % (4.7)% (12.2)% 6.4 % (5.2)%1991 11.3 % 8.9 % 35.6 % 13.1 % 12.1 % 30.1 % 18.3 %1990 (34.4)% (36.1)% (11.0)% (3.9)% (23.5)% (3.2)% (17.0)%1989 2.5 % 1.7 % 15.1 % 28.5 % 10.5 % 30.0 % 16.6 %

Average AnnualTotal Return 1989 - 2Q99 (1.9)% (3.4)% 9.0 % 14.2 % 5.7 % 19.2 % 11.0 %

Cumulative Total Return 1989 - 2Q99 (18.3)% (30.3)% 147.7 % 302.7 % 78.3 % 534.2 % 198.7 %

Exhibit D��Sit/Kim International Investment Associates, Inc.��

Local European Market Index Performance(Figures Are Stated in Percent Change)

SOURCE: THE WALL STREET JOURNAL AND BLOOMBERG L.P.

COUNTRY US$ LOCAL US$ LOCAL

Austria (ATX) (0.4) 3.5 (4.1) (2.5) 9.9 (11.5)Belgium (Bel-20) (7.3) (3.6) (4.1) (20.9) (10.8) (11.5)Finland (HEX) 9.0 13.3 (4.1) 21.9 37.4 (11.5)France (CAC) 3.9 8.1 (4.1) 2.1 15.1 (11.5)Germany (DAX) 5.9 10.1 (4.1) (4.6) 7.5 (11.5)Ireland (IRISH) (12.6) (9.2) (4.1) (14.4) (3.6) (11.5)Italy (BCI) (6.9) (3.2) (4.1) (9.0) 2.6 (11.5)Netherlands (CBS) 2.5 6.6 (4.1) (4.6) 7.6 (11.5)Portugal (BVL30) (7.5) (3.9) (4.1) (17.8) (7.4) (11.5)Spain (Madrid) 0.4 4.4 (4.1) (7.5) 4.2 (11.5)

Denmark (KFX) 3.4 7.6 (4.1) (10.6) 1.1 (11.7)Greece (ASE) 14.4 19.4 (3.7) 31.0 47.3 (10.8)Norway (Ind) 10.0 11.0 (1.2) 21.0 25.5 (3.0)Sweden (General) 8.2 10.6 (2.4) 12.5 17.4 (4.2)Switzerland (Swiss) (7.3) (3.1) (4.4) (14.4) (3.5) (8.8)United Kingdom (FT-200) (1.7) 0.4 (2.4) 2.1 7.4 (5.2)

EXCHANGE RATESFROM PRIOR QTR

STOCK MARKET

SECOND QUARTER 1999

EXCHANGE RATES12/31/98 - 6/30/99

STOCK MARKET

FIRST HALF 1999

Exhibit E��Sit/Kim International Investment Associates, Inc.��

Local Asian Market Index Performance(Figures Are Stated in Percent Change)



Hong Kong (HSI) 23.5 23.7 (0.1) 34.5 34.7 (0.1)Japan (Topix) 9.4 11.8 (1.8) 21.5 30.3 (6.3)Singapore (STI) 45.1 42.8 1.4 51.0 55.6 (3.0)South Korea (KSCI) 51.2 42.7 6.0 63.3 57.0 3.9Taiwan (TWI) 26.2 23.0 2.6 31.5 31.9 (0.3)

Indonesia (JSI) 118.9 68.2 31.0 98.5 66.3 18.0Malaysia (KLCI) 61.3 61.3 0.0 38.4 38.4 0.0Philippines (PCI) 24.9 22.6 2.1 28.8 26.3 3.1Thailand (SET) 51.1 48.2 2.1 45.9 46.6 (0.8)

Australia (AOI) 5.3 0.1 3.5 15.4 5.5 7.2New Zealand (NZ40) (0.2) (0.3) (1.2) 4.6 3.4 0.2

SECOND QUARTER 1999 FIRST HALF 1999STOCK MARKET EXCHANGE RATES

12/31/98 - 6/30/99EXCHANGE RATESFROM PRIOR QTR

STOCK MARKET

Exhibit F��Sit/Kim International Investment Associates, Inc.��

Local Latin American Market Index Performance(Figures Are Stated in Percent Change)



Argentina (Merval) 18.2 18.8 0.0 16.0 16.0 0.0Brazil (Ibovespa) 6.5 8.7 (1.5) 18.2 71.4 (32.1)Chile (General) 8.0 15.4 (6.3) 21.0 32.8 (8.8)Mexico (Bolsa) 20.9 18.2 0.9 55.8 47.2 5.0Peru (General) 13.7 13.6 (0.1) 18.5 25.0 (5.8)

FIRST HALF 1999STOCK MARKET EXCHANGE RATES

12/31/98 - 6/30/99

SECOND QUARTER 1999STOCK MARKET EXCHANGE RATES

FROM PRIOR QTR

Exhibit G��Sit/Kim International Investment Associates, Inc.��

Selected Markets' Securities Valuation

a REPRESENTS LOCAL MARKET INDEX IN USD.Source: Bloomberg, Jardine Fleming, Merrill Lynch, Salomon Smith Barney, Goldman Sachs, SBC Warburg

Dillon Read, W.I. Carr Securities, BZW Securities, Latinvest, Morgan Stanley Capital International,ING Barings Securities and SKI estimates, 6/30/99.

2000E 1999E 2000X 1999X

EUROPEFrance 15.1 8.1 10.0 10.0 21.5 22.5Germany 7.5 10.1 10.0 6.0 19.5 21.0Netherlands 7.6 6.6 10.0 8.0 22.0 24.0Switzerland (3.5) (3.1) 10.0 10.0 21.0 25.0United Kingdom 7.4 0.4 10.0 5.0 22.0 23.5

ASIAHong Kong 34.7 23.7 15.0 10.0 17.3 20.0Japan 30.3 11.8 15.0 15.0 45.0 50.0Singapore 55.6 42.8 15.0 25.0 23.0 26.5South Korea 57.0 42.7 65.0 82.0 17.0 28.0Taiwan 31.9 23.0 20.0 22.0 24.4 29.0Indonesia 66.3 68.2 45.0 47.0 10.0 16.0Malaysia 38.4 61.3 0.0 90.0 17.0 20.0Philippines 26.3 22.6 22.0 30.0 21.5 17.0Thailand 46.6 48.2 (5.0) (42.0) N/A N/A

LATIN AMERICAArgentina 16.0 18.8 10.0 (5.0) 14.4 17.0Brazil 71.4 8.7 18.0 3.0 7.2 9.6Chile 32.8 15.4 10.0 7.0 14.5 16.0Mexico 47.2 18.2 20.0 35.0 12.0 14.1 1.7

0.6

2.7

1.91.1

4.63.0

2.51.00.82.0

3.80.7

1.71.6

1.22.4

% Change Year-to-datea

First Half 1999 6/30/99

1.9

Estimated EPS % Change

Estimated P/E Current Dividend Yield (%)

% Change Quarter Endeda

1999

Exhibit H��Sit/Kim International Investment Associates, Inc.��

Value of Euro Has Declined

Source: New York times, July 10, 1999.

Exhibit I��Sit/Kim International Investment Associates, Inc.��

European Consumer Confidence is Strong

Source: J.P. Morgan, Global Equity Weekly, June 1, 1999

Exhibit J��Sit/Kim International Investment Associates, Inc.��

Key European Economic and Investment Variables

Source:: Goldman, Sachs & Co., Lehman Brothers, J.P. Morgan, Merrill Lynch and SKI estimates, 6/30/99.

COUNTRY 2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998Austria 2.4 2.2 2.9 1.7 1.5 1.5 2.5 2.5 3.0 9.0 8.0 12.0Belgium 2.3 2.0 2.8 1.5 0.9 1.0 2.5 2.5 3.0 8.0 4.0 3.0Finland 3.5 2.5 4.9 1.4 0.9 1.4 2.5 2.5 3.0 10.0 7.0 12.0France 2.7 2.2 2.9 1.0 0.7 0.7 2.5 2.5 3.0 10.0 10.0 10.0Germany 2.5 1.6 2.8 1.1 0.7 0.9 2.5 2.5 3.0 10.0 6.0 10.0Ireland 6.0 8.0 8.0 2.5 2.2 2.0 2.5 2.5 3.0 10.0 10.0 13.0Italy 2.3 1.3 1.4 1.6 1.6 1.7 2.5 2.5 3.0 10.0 9.0 10.0Netherlands 2.5 2.5 4.2 2.0 1.8 2.0 2.5 2.5 3.0 10.0 8.0 10.0Spain 3.3 3.2 3.8 2.3 2.0 1.8 2.5 2.5 3.0 12.0 10.0 10.0

Denmark 2.2 1.8 2.8 2.5 2.5 1.8 2.5 3.0 3.7 9.0 5.0 2.0Greece 3.5 3.2 3.2 2.3 2.4 3.9 3.0 6.0 9.5 16.0 18.0 38.0Norway 2.0 0.8 2.0 2.4 2.5 2.3 3.0 3.8 5.3 8.0 5.0 2.0Sweden 2.9 2.5 2.8 1.5 0.5 0.4 2.7 2.9 3.0 10.0 8.0 10.0Switzerland 1.8 1.3 2.0 1.1 0.3 0.0 1.0 1.0 0.5 10.0 10.0 10.0United Kingdom 2.7 0.9 2.1 2.2 2.0 2.7 3.5 4.5 6.3 10.0 5.0 6.0

GDP (%) INFLATION (%)SHORT-TERM

INTEREST RATES (%)EPS (%)

Exhibit K��Sit/Kim International Investment Associates, Inc.��

Unemployment within the EU

Source: KPMG corporate tax rate survey.

41.741.3

40.2

39.6

35.0

35.0

34.034.0

32.0

31.028.0

28.0

51.6

40.0

37.5

43.6-56.7

35.0-40.0

Germany

France

Italy

Belgium

Greece

Portugal

Luxembourg

Netherlands

Spain

Austria

Denmark

Ireland

UK

Sweden

Finland

Japan

US

Exhibit L��Sit/Kim International Investment Associates, Inc.��

Euroland Corporate Tax Rates

Exhibit M��Sit/Kim International Investment Associates, Inc.��

Market Valuations Versus Bonds and Cash

Exhibit N��Sit/Kim International Investment Associates, Inc.��

European Earnings Yield Relative to the 10-Year Bond Yield

*

One Standard Deviation

Exhibit O��Sit/Kim International Investment Associates, Inc.��

Comparative Equity Market Data

Exhibit P��Sit/Kim International Investment Associates, Inc.��

Excess European Equity Returns

Exhibit Q��Sit/Kim International Investment Associates, Inc.��

EuropeanEquilibrium P/E Calculations

Exhibit R��Sit/Kim International Investment Associates, Inc.��

German GDP and Employment Data

Source: Datastream, Investors Business Daily, June 15, 1999

Exhibit S��Sit/Kim International Investment Associates, Inc.��

Key Asian Economic and Investment Variables

A JAPAN FISCAL YEARS END IN THE FOLLOWING YEAR.

Sources: Bloomberg, Jardine Flemings, ING Barings Securities, JP Morgan, Salomon Smith Barney, S.B. Warburg, Indosuez W.I. Carr, SG Securities and SKI estimates 6/30/99.

2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998

Hong Kong 2.0 (2.0) (5.0) 1.0 (2.0) 2.5 8.3 8.0 9.0 15.0 10.0 (20.0)Japan (Mar Year)a 0.0 0.5 (2.5) 0.0 (0.5) (1.0) 3.0 3.0 2.5 15.0 15.0 (25.0)Singapore 3.0 2.2 1.5 1.5 0.0 (0.3) 6.5 5.8 6.0 15.0 25.0 (20.0)South Korea 5.0 6.7 (5.5) 3.5 2.5 7.5 7.5 6.0 7.5 65.0 82.0 (18.0)Taiwan 5.2 4.7 4.8 2.0 1.0 1.7 8.0 8.0 7.9 20.0 22.0 0.0

China 6.5 6.0 7.8 1.0 (0.5) (0.8) 3.8 4.5 5.1 10.0 15.0 (10.0)Indonesia 3.5 (3.0) (13.7) 10.0 30.0 58.5 18.0 24.0 46.0 45.0 47.0 (40.0)Malaysia 3.0 1.0 (7.5) 4.0 5.0 5.3 6.0 7.0 8.5 0.0 90.0 (47.0)Philippines 3.0 2.0 (0.5) 7.0 7.5 9.7 11.0 12.0 17.5 22.0 30.0 (26.0)Thailand 3.5 1.2 (8.0) 2.5 2.0 8.1 8.0 8.5 11.5 (5.0) (42.0) (40.0)

Australia (Jun Year) 3.8 4.2 3.9 2.2 1.9 1.5 5.3 5.3 5.6 13.0 10.0 5.6New Zealand (Mar Year) 2.2 (0.5) 2.3 1.8 1.2 1.3 5.5 5.5 7.0 18.0 5.0 8.5

GDP (%) INFLATION (%)PRIME LENDING

RATES (%)EPS (%)

Exhibit T��Sit/Kim International Investment Associates, Inc.��

Asian Economic Indicators

Source: Goldman Sachs & Co.

Exhibit U��Sit/Kim International Investment Associates, Inc.��

Asian Economic Indicators

Source: Goldman Sachs & Co.

Exhibit V��Sit/Kim International Investment Associates, Inc.��

Investors Anticipate Recovery in Japan

Source: Financial Times, July 19, 1999

Exhibit W��Sit/Kim International Investment Associates, Inc.��

Business Confidence in Japan

Source:: Bear Stearns/Latin America Watch, July 5, 1999

Exhibit X��Sit/Kim International Investment Associates, Inc.��

Japan’s Long Recession Appears to Have Ended

Source:: Bear Stearns/Latin America Watch, July 5, 1999

Exhibit Y��Sit/Kim International Investment Associates, Inc.��

Key Latin American Economic and Investment variables

Source: Santander Investment, Goldman, Sachs & Co., latinvest, Bear Stearns, Merrill Lynch,Salomon Smith Barney and SKI estimates, 6/30/99.

COUNTRY 2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998 2000E 1999E 1998

Argentina 3.5 (3.0) 4.2 0.0 (1.0) 0.7 7.0 7.0 9.0 10.0 (5.0) (11.0)Brazil 3.0 (1.5) 0.2 8.0 9.0 (1.8) 18.0 21.0 29.0 18.0 3.0 (18.0)Chile 4.0 0.5 3.4 4.0 4.5 4.7 7.0 8.0 11.0 10.0 7.0 (15.0)Mexico 3.0 2.8 4.8 13.0 15.0 18.6 19.0 21.0 34.0 20.0 35.0 (35.0)Peru 4.0 1.5 0.7 5.0 5.5 6.0 13.0 14.0 17.0 15.0 10.0 (38.0)

SHORT-TERM INTEREST RATES (%)

EPS (%)INFLATION (%)GDP (%)

Documents

n Sit/Kim International Investment Associates, Inc · Sit/Kim International Investment Associates, Inc. July 26, 1999 Investment Outlook and Strategy Page 2 Sit/Kim International