Market & Economy Update
March 3, 2009

Dear Clients,
These updates, which used to be quarterly, are practically turning into weekly occurrences. This
is what happens when the worst year for the stock market since 1931 is followed by the worst
January and February in history. Last year the stock market lost 37%, and by the end of Tuesday
was down another 23% this year alone.

You will soon be receiving your monthly statement. Hopefully you aren’t watching the markets
and your account daily. I do, and it’s not easy these days. While our cash and bonds certainly
provide a substantial cushion, nothing on the stock side has been holding up during this
continued rout.

First the negative: I am watching your investments so very closely because I will indeed sell all
of our stock-based investments if it looks like our economy is literally going to collapse. Despite
the ongoing barrage of negative news, I still believe this is quite unlikely. But it is possible. In
particular, I am concerned about two developing economic problems, and one that remains
unresolved. One of the new problems involves several very large insurance companies that are in
trouble. These include Met Life, Hartford, and Principal Life. If major insurance companies
break, the results will be very bad indeed. Another major area of concern involves Eastern
European countries and several Western European countries. The concern is that entire countries
may become insolvent. While I am very glad we exited all of our pure international stock funds
last September (international stocks have gone down another 25% this year after losing 55% in
2008), if a number of European countries should essentially go bankrupt, the entire world
economy could crash. And then we have the fact that our major banks remain quite troubled, and
the credit markets are still largely frozen. That is clearly a lot of negative news.

Now the positive: Systemic financial problems, i.e. those that lead to collapse, can be resolved
through central bank action. In fact, they always are eventually. Of course, governments and
central banks must act quickly, as every day the financial system is broken, the entire economy
suffers more. At last count, the Federal Reserve Board has taken over a dozen measures to
prevent our financial system from collapsing. And while they won’t give out the details,
European Union officials met this week and guaranteed they have a plan in place to prevent
European countries from becoming insolvent. Yes, governments and central banks have made
and will make many mistakes, but the financial system will get fixed.

So while we continue to have very large financial problems, the weight of economic evidence
still says we will not collapse. This remains the case, regardless of the rampant fear and panic we
have been seeing on television and from the public in recent days and weeks. Please keep in
mind that, in every terrible economic and market downturn, things begin to turn around (slowly)
right at the point that nearly everyone is sure we will never grow again. But we will. Looking
back two years from now, we are likely to see that the two worst quarters were the end of last
year and the first quarter of this year. This does not mean everything is going to become rosy at
the end of this quarter! It does, however, mean that the “slope” or momentum of the downturn
will most likely lessen in the relatively near future. We’ll still be in negative economic territory,
but the descent will be milder. Fortunately, this is all it will take for the stock market to take off.
Those who sell everything now will be waiting for everything to appear safe and secure in the
economy before reinvesting. But that will not occur for, most likely, another year after the
downward momentum begins to lessen and the stock market takes off. By the time people feel
safe again, the stock market will be up around 30%. That’s what those who sell now will most
likely miss out on, and that’s why I don’t want to follow the selling crowd now when the markets
are so low.

When we look at how our investments have been doing, most of our recent (paper) losses have
come from exactly two holdings – Berkshire Hathaway stock and the Fairholme Fund. Warren
Buffett of Berkshire Hathaway has been all over the news recently after putting out their annual
report on Saturday. Almost all of the headlines were exceptionally negative, saying Mr. Buffett
is predicting much more economic turmoil. That is indeed true, but in the same sentence he said
this tells us nothing about the stock market, for the reasons just discussed above. Other headlines
made it appear as if Berkshire Hathaway is losing money and is in some sort of trouble. This
could not be further from the truth, as anyone who takes the time to read, and has the financial
sense to understand, their 70 page annual report would know. Of course Berkshire’s profits were
down last year. In 2007 they made $13 billion, and last year they reported earnings of $5 billion.
However, they actually made an additional $5 billion that wasn’t reported due to an obscure and
meaningless accounting requirement. So in reality their profits did fall 23% last year, but they
still had good earnings. In fact, even with “only” $5 billion in profits, they did three times better
than the average company last year. And if a person reads and understands their financial
statements and position, you see they are poised to do remarkably well going forward. This is
what Mr. Buffett said, and it will turn out to be the case.

I hear many investors across the country expressing the belief that it will take them forever to get
back to where they started with their stock investments. While that may indeed be somewhat true
for average stocks, you should not have this concern about Berkshire Hathaway, and you
definitely should have no concern for the Fairholme Fund. Both will get back to where we
started and then deliver excellent gains for you, and this should occur before you need to spend
that money. For example, the stock market lost half its value in 1973-1974. As I mentioned in
last week’s report, by the end of 1974 nearly everyone was convinced the stock market would
not recover for years – if ever. Mr. Buffett disagreed completely. Who was correct? The very
next year the stock market began to do very well. And over the next 12 years Berkshire
Hathaway’s value increased by 21.9%, 59.3%, 31.9%, 24%, 35.7%, 19.3%, 31.4%, 40%, 32.3%,
13.6%, 48.2%, & 26.1%. So yes, I remain completely confident Berkshire will get back all our
losses and deliver excellent profits for us. If anything, the Fairholme Fund may do even better
than Berkshire Hathaway. Since most of our (paper) losses have come from these two
investments, I am as optimistic as ever that your retirement money is very well-positioned to
achieve your financial goals. That being said, I am still patiently waiting on most additional
stock fund purchases and have no plans at this time to make changes in our stock funds.

We will conclude with a brief look at our bond fund investments. The last two purchases I made
for most clients were bond funds – TCW Total Return Bond fund for IRA accounts and
Federated California Municipal Income fund for taxable accounts. The California municipal
bond fund has gone up 6% this year. TCW is up a very respectable 1.8% so far this year. This is
one of the safest bond funds in the country, and it is paying 7.22% in interest this year. That is a
whole lot more than any money market fund. We are therefore going to purchase some more of
this fund in most accounts this week. It has never lost money in any year and is safely paying
over 7% in interest, a combination that is ideal for retirement money in this economy.
In closing, I would like to thank all our clients for your patience and understanding. These are
the most difficult economic times we have ever seen. But when this horrendous economic storm
passes, your account – invested in the finest funds in the history of our country – will again shine
and should deliver the retirement income you need.

Sincerely,
Richard Morey