2 These actions have led to forced and indiscriminate selling in security markets around the world,which in turn has caused other investors to panic or simply to sell, to get out of the way of otherforced sellers.As a fund which is generally substantially more long than short, we have also suffered largemark-to-market declines in our long investments. Year to date, however, our performance hassubstantially exceeded that of the broader equity markets, which at this writing have seen a morethan 34% decline. Our outperformance is largely due to large gains on our investments in LongsDrugs and Wachovia Corporation as well as profits on our credit default swap and other shortexposures. Our market losses have been further mitigated because we operate unleveraged andhave substantial cash balances. Currently, we have cash and near-cash (Longs Drugs andWachovia/Wells Fargo long/short) equal to approximately 39% of our capital.When, you might ask, will the selling end? While I don’t proclaim to be a marketprognosticator, I will make a few observations. Unlike the deleveraging that takes place whenbanks and other financial institutions sell assets to meet regulatory requirements, which istypically a longer term process, the forced deleveraging that is now taking place in the equitymarkets is being implemented largely by the prime brokerage firms and margin accountmanagers at broker dealers around the world. Prime brokers are not known to be laggardly intheir approach to liquidating an account that no longer meets margin requirements. This is likelyto be even more true in the current environment. As such, it may be reasonable to conclude thatthe forced liquidation that is now taking place may not be a prolonged process.Security prices around the world have come down tremendously. In the larger capitalizationU.S. markets, which are the focus of our strategy, the reductions have been substantial. As of themarket close on October 31
, the S&P 500 is down 34.0%, year to date, and down by 37.5%from its high on October 31, 2007; and this is after last week’s rally in which the S&P 500 rosemore than 12% from the lows. Unlike the bear market of 1973 and 1974, in which stocksdeclined by 45% from the highs, this bear market was not preceded by the “Nifty 50” bubble inwhich large capitalization growth stocks traded at extraordinary valuations. While valuationswere not cheap one year ago, in a long-term historical context, the market as a whole(particularly if one were to exclude financials) was not particularly expensive either.As such, in today’s market, we are finding extraordinary bargains, the kinds of opportunities thatare normally associated with market bottoms. While there are still weak and poorly capitalizedbusinesses that are likely still overvalued, the high quality, well-capitalized, larger capitalizationbusinesses which are the focus of our strategy look very cheap to us.While this means that now is likely to be a much better time to be a buyer rather than a seller, itdoes not mean that the market will not continue to decline, even substantially, from currentlevels, particularly in the short term. In fact, because of tax-loss selling over the next 60 or sodays, there will likely be additional selling pressure. At some point, however, the forced sellingwill come to an end. Large amounts of cash are sitting on the sidelines waiting to be deployedwhen investors feel the coast is clear. In the event the market were to start to rise again, it wouldnot be a surprise to see institutional, retail, and hedge fund investors rapidly deploy capital so asnot to miss a, perhaps, explosive market rally.