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VIEW FROM EDGEWOOD



ECONOMENTS

Edgewood Management LLC
April 6, 2006

The View from Edgewood

On March 20th three partners from Edgewood along with 1297 of our closest friends went to see the new chairman of the Federal Reserve, Ben Bernanke, give his first speech in New York City at a meeting of the Economic Club of New York. This was one of the largest crowds ever to attend a speech in front of this august group, and we all got a very good university lecture on what is technically called the term structure of interest rates. What the audience did not get was a clear indication of what the near-term direction of interest rates would be. While the Fed raised its short term rates twice in this quarter, long term interest rates hardly moved until the last couple weeks of March. Chairman Bernanke attributed these lower than expected long term rates to either an excess of savings in the world, some of which are flowing into the U.S. Treasury market, or a lack of concern about inflation on the part of the bond market. The first scenario could be stimulative and inflationary; the second is benign and would indicate interest rates do not need to go up much more.

While we now know that the new head of the Fed admires ambiguity, albeit with more direct language than his predecessor, there was no ambiguity that the U.S. economy rebounded nicely in the first quarter of 2006 from the weakness caused by the hurricanes and the resulting spike in energy prices in the fourth quarter of 2005. Oil prices, which have stayed stubbornly above $60 a barrel, have not set off an inflationary spiral as shown by the .1% increase in the core consumer price deflator for February that was released on March 31. We have stopped trying to guess when the Fed will stop raising short-term rates, but we believe that while they try to keep inflation in check they want to be very careful about choking off the economic expansion.

We have been telling you for several quarters that as the Federal Reserve continued to raise interest rates the market would start to look more favorably on growth stocks. This appeared to be happening in the first quarter; while energy and other commodity based stocks did well, certain growth names also turned in a solid quarterly performance. This was by no means across the board, but we do not expect a replay of the late 1990’s where anything that was, or was perceived as, a growth stock increased dramatically in value. As we have pointed out before, certain long time growth areas such as media or pharmaceuticals have lost their growth mantle. On-line franchises like Google have captured the growth in advertising in this economic expansion, leaving print media and radio in particular gasping for air and growth. Biotechnology and medical devices have replaced the old-line pharmaceutical stocks in growth portfolios, but the combined value of these industries is still much smaller than the total value of the pharmaceutical companies.

Growth is a more difficult item to find and we believe even more strongly that concentrated portfolios and successful stock picking will provide above market returns. Growth stocks remain much more reasonably valued than in the 1990’s and should therefore be less vulnerable to the effects of higher interest rates, which are what ended the bull market in 2000. With our two new partners in place we have expanded our analytical team and have rededicated ourselves to even more careful attention to company fundamentals, which we believe will serve our client’s well over the next couple of years.


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