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VIEW FROM EDGEWOOD



ECONOMENTS

Edgewood Management LLC
April 3, 2008

The View from Edgewood

The world economy is still battling to keep itself upright as the second, or maybe third, round of the credit crisis sweeps through financial markets. Many dark scenarios could be and have been painted. It would be naïve to simply state that the U.S. and international economies will survive with no lasting damage resulting from the current chaos in the credit markets. Had the Bear Stearns rescue by the Federal Reserve and JP Morgan Chase not occurred it would have unleashed a tsunami of counterparty defaults throughout the credit and banking systems. However, the Fed acted decisively and quickly and averted what could have been an unprecedented situation. While the spiral of debt creation this decade is now unwinding, it will unleash most of its pain on the direct beneficiaries and victims of its creation. The end of this credit squeeze will produce more prudent use of debt and derivative instruments and better regulatory oversight that may mitigate the next crisis.

After underperforming for the last three years the U.S. market was the best performer among both established and emerging stock markets in the first quarter of 2008. The equity markets in general have been buffeted bystanders to the drama in the credit markets; whiplash has certainly been suffered by market participants, but that is a minor injury given what has occurred since last summer. The U.S market has outperformed others for the simple reason that it has lagged most markets for most of this decade. S&P 500 earnings should be $93 this year, a 109% increase since 1999. Over those nine years the index has increased 9.6%. Of course this includes the bear market of 2000 to 2002, but the gain in the S&P 500 has fallen significantly behind the growth in profits. Even if S&P profits do not meet the estimated $93 for this year, the market has stayed far behind their growth and should not be punished too severely for an earnings slowdown.

The Federal Reserve will keep interest rates low until they are confident the credit markets and the economy have stabilized. This is another factor in keeping U.S. equities relatively attractive. Once it appears that the dollar has stopped declining (we think it is close to that point now) foreign investors should start to pay closer attention. Of course this decline in the dollar is helping exports expand, which is keeping the economy growing.

In the first quarter we added to our healthcare exposure and have continued to be underweight financials. Our portfolio companies have maintained their growth rates while the market has compressed their multiples. We feel it is ideally positioned for a market rebound.


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