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Edgewood Management Company

VIEW FROM EDGEWOOD



ECONOMENTS

Edgewood Management Company
January 7, 2005

The View from Edgewood

The presidential election was long, contentious and close, but we had a clear winner this time. Iraq continued to be the dominant international story, with rays of hope occasionally penetrating an overall difficult situation; successful elections in January 2005 could make a big difference in the world's perception of the situation there. China 's continued red-hot growth and its effect on the prices of industrial commodities, particularly oil, was the dominant economic story of the year. The weakening dollar and its positive and negative economic effects will compete with China as the major economic focus in 2005.

Even in the face of record high oil prices and five small rate hikes by the Federal Reserve the U.S. economy showed consistent strength throughout the year. Real GDP growth for all of 2004 will probably come in around 3.5%, with 3% a consensus estimate for 2005. The spike in oil prices probably cost some growth, but the American economy is much more energy efficient than in the 1970's. If anything, the spike in oil prices may turn out to have a positive side if the country is reminded that oil is a diminishing resource we have to import from parts of the world that are less than friendly to the U.S.

The markets completed the first back to back years of positive returns since 1998 and 1999, but contrasted with the overhang of major events the market actually had a relatively dull year. Despite a sharp drop in July, overall equity market volatility was at one of the lowest levels since World War II. Most of the year's equity gains occurred in the fourth quarter after uncertainty about the election was lifted and oil prices declined from their peak.

The two strongest sectors in the S&P 500 were energy and utilities, hardly growth areas. Almost all growth sectors badly lagged as can be seen by the more than four percentage point difference in performance between the S&P500 and the Russell 1000 growth index. In addition it became clear during 2004 that a couple of industries long represented in growth portfolios had lost their growth characteristics. Pharmaceutical companies were a bastion of reliable growth for decades. A steady pipeline of new products protected by patents and little pricing pressure created consistent sales and profit growth and lots of extra cash. At the turn of the century it became evident that the pipelines were shrinking and the companies' aggressive use of patents had begun to backfire as some of their biggest selling and most profitable drugs were facing lengthy litigation challenging the patents. In addition, their annual price increases on patent protected drugs had begun to cause them major political problems. 2004 was the year it became evident that this is an industry-wide problem, with the coup de grace being the controversy surrounding COX-2 drugs (first Vioxx then Celebrex). We believe that growth in health care in the future will come from the biotechnology and medical device areas.

A sea change has also taken place in the media world where some of the traditional media areas of advertising growth such as radio and newspapers saw enough of that advertising spending go to the Internet that their rates of growth have become permanently slower. At the moment the most prominent Internet advertising platforms such as YAHOO! and Google are very expensive, but that will be an area of future interest for Edgewood. We want to wish everyone a happy and prosperous New Year.


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