Winter 2001

Wolf! Wolf! Wolf!.

New Year Greetings:

February 1, 2001

Happily we write to you with overall account values having improved markedly since year-end 2000. For the record the Model Portfolio staggered to the finish of the year 2000 with a gain of 1% which was much better thatn the popular averages. The NASDAQ finished the year down 40%, the S & P 500 was down 9%, and the DJIA was down 7%. Most accounts finished the year up or down 5% although there were a few accounts down 10%.

On a much more positive note, the rally in early January allowed us to raise cash with a vengeance while still seeing overall improvement in all account values. Last letter we remarked that we wanted to soon have a large cash position because we wre nervous about the markets. We remain very concerned about the markets, both stock and bond and so we acted on our gut feeling and sold into the rate cut rally to raise our cash/bond levels in all accounts.

A new year offers a new beginning and we are thankful for the rally in our stocks. As we write most accounts are up 10% to 20% from their year-end values and are 70% cash or short term bonds. Some more aggressive accounts are trading some big cap stocks (SBC, Bellsouth, Disney, McDonalds, and UAL) but we have reduced our basic stocks holdings to four. Those stocks are Wild Oats, Ohio Casualty, Urban Outfitters, and Excite@Home. We also still own Midwest Express for a trade, and have a small position in some aggressive accounts in Cott Corp. We used the rally to eliminate other positions including overly large positions in Abercrombie & Fitch, Williams Sonoma, A T & T, and Lucent. We've had good luck trading Abercrombie and Williams Sonoma over the last eight months, and terrible luck with A T & & and Lucent. We sold the A T & Tbecause we don't agree with the plan to split the company up. While we have no doubt about the value of the various parts, we think management is letting Wall Street run the company. We sold Lucent because we think it will reach single digits before the tech wreck collapse is over. Lucent and A T & T were both relative value purchases. Bu that we mean that we bought Telephone and Lucent because both stocks were relatively cheaper than other stocks doint the same kind of business. Such an approach usually works in rising markets as investors look for undervalued securities as a way to participate; but in falling markets such an investment approach causes pain as all stocks drop, with the relatively undervalued ones dropping fastest. Luckily, we had some nice winners to offset our losses and we just decided to clear the boards of all our "relative value" investments when we went to cash.

During December, when our account values reached their lows we happened to remark to a client that we felt like the boy who cried wolf. As the market dropped in December we kept adding positions in the hopes of a January rally. At the same time we couldn't help but think that maybe the market downturn we had been predicting for the past few years was upon us, and rather than being largely in cash we were fully invested. 1999 had been good to our accounts and until November 2000 we had weather the NASDAQ crash with relatively positive results. We hoped for a year end rally. There was a small up tick the last few days of the year 2000, and when the Fed dropped the discount rate by one half per cent on January 3, 2001 we gladly reduced our market exposure as quickly as we could. In doing so we left some money on the table in some stocks. But our overall approach to investing has always been bottom line guided and when we saw that accounts that had been down 10% for the year 2000 were now up 5% on a one year and five day basis, we were positive our sell strategy was sound.

As we write, many accounts are up 5% to 15% on a thirteen month basis while all the market averages remain negative over the same time period. We and most of our account have well outperformed over the past two years and we don't want to give our gains back. Moreover, with our very substantial cash hoard, we can again cry "Wolf!".

The reason we have raised so much cash is that in the past when we have gone to a 50% cash/bond position we still have not avoided suffering greatly in substantial downturns. We are very negative because we do not believe that interest rate cuts from present levels will have the effect predicted. When interest rates were cut in the mid 1990s, the markets were a half their present level, in the early 1990s the markets were one third the present level. The speculative building in the big cities and even small towns has been going on for years now and lower rates may mitigate carrying costs, but the rash of layoffs and bonus cuts will have on the projected surplus, long bond prices will collapse. Interest rates in Japan are near zero, but those low rates haven't rescued the Japanese economy from the excesses of the late 1980s. So too for our economy and stock markets.

We think the market may continue to rally for a month or two, but we expect a serious sell-off later in the year and we don't want to try and catch the last run. Hopefully even the stocks we still hold will give us 50% returns in the coming rally and will allow us to reduce our exposure to the stock market even more. We are thinking 1973-1974 type action, not 1987 or any of the 1990s corrections. Thus our caution.

Model Portfolio

We've owned Wild Oats sporadically over the past few years at much higher prices. Luckily we sold most shares before the collapse last year. The company owns and oeprates natural foods stores throughout the country and has grown rapidly by purchasing locations. This strategy led to severe integration problems and resulted in lower operating earnings and special charges in the year 2000. With a big write-off to be announced in the next month, hopefully OATS will begin showing better same store sales results and earnings in 2001. At its present price with sales of almost $900 million, the company is being valued in the stock market at under $200 million including debt. Insiders were big sellers at $19 per share in March 2000, and big buyers at $5 per share in December 2000.We had the same pattern. At $6 per share we like the risk reward ratio and consider this an investment for turnaround.

Ohio Casualty is an auto and casualty insurer that earns $2 per share from its investment portfolio. The problem is that OCAS has been losing $2 per share on its underwriting. New management promises changes. Book value is $17. Another good turnaround situation.

We've also owned Urban Outfitters over the years but never at this low a share price. URBN locates its stores in college towns like Evanston and Ann Arbor and markets to the college market. Also runs stores called Anthropologies and has catalogues and web sits. Insiders own a good chunk of stocks and have run the store since inception. Missed the armet this year but will still earn money and has no debt.

Excite@Home provides internet hookup through cable wires. Company is now controlled by A T & T. A T & T just paid $4 billion dollars for a 40% interest in the company by buying out partners Comcast and Cox. At the time A T & T paid 4 billion for a 40% interest - the whole company was being valued in the marketplace at $3 billion. One reason we don't own A T & T anymore. Also one reason we own ATHM. We presume that A T & T will buy the rest of the public shareholders out of make a special effort for this company to succeed. It's a relatively small position in most accounts except small accounts. ATHM has 3 million subscribers now and is adding paying subscribers at a nice clip.

Cott Corp. bottles soft drinks for private label users. Having owned before we own in small amounts in large accounts and could easily be out of the stock on any more. Same goes for Midwest Express which we bought for a trade at year end.

Thanks to all who contributed to our Sri Lanka kids.

New Letter
Summer 2001
Spring 2001
The factual statements herein have been taken from sources we believe to be reliable but such statements are made without any representation as to accuracy or completeness or otherwise. From time to time the Lemley Letter, or one or more of its officers or employees, may buy and sell as agent the securities referred to herein or options relating thereto, and may have a long or short position in such securities or options. This report should not be construed as a solicitation or offer of the purchase or sale of securities. Prices shown are approximate. Past performance is no indication of future performance.