Baldwin Management, LLC.

We have said it before – in 2002, there was no place to hide. According to recent statistics, 75% of all stocks on the S&P 500 fell during the year, the worst performance since 1974.

Every single sector of the S&P 500 declined, the first time that this has ever happened.

In short, the only equity strategy that worked for 2002 was a very simple one indeed: don’t own any equities! The past year was all about risk premiums, and in this instance, rising risk premiums. In other words, 2002 was a year in which PE multiples contracted.

All sectors in the S&P had more stocks decrease than increase and the downside breadth in the market was amazing.

There was also no safe haven by investment style or capitalization. Value stocks declined roughly as much as growth and small caps mirrored the negative returns in large caps.

AND NOW, A REVIEW OF OUR REPORT CARD

PREDICTIONS FOR 2002 YES NO COMMENT

Fed will keep rates low but nearly at an end X Did cut rates once (.5%) due to fear of “Double Dip”

to cutting rates

Inflation still not a problem X Still true

Oil prices will not increase drastically X Oil prices up at the end of the year on war fears & the Venezuela situation

Euro should strengthen X It has, ending the year +18%

Mr. Bush’s popularity will decline X As predicted, but he is still popular

U.S. economic growth will approach 2% X 4^th quarter expected to be weaker than 3^rd quarter

Investor psychology will improve X Only gotten worse

Japanese yen devaluation will be controlled X Yen actually appreciated, much to chagrin of Japanese

India and Pakistan will not deteriorate into X No instant problems

worldwide crisis

We will not have 3 down years for the X Unfortunately, we did
stock market

By our score keeping, we were right 6 out of 10. In most businesses (including investment management) this would be considered a “back slapping” result. However, we missed big on investor psychology which seemed to override everything else! (Perhaps we should hire a psychologist, as we have gotten this area wrong two (2) years in a row!)

A LOOK AHEAD

A current worry in the marketplace is the specter called deflation. The last time the United States suffered a deflationary period was during the Great Depression of the 1930s. A current example, which is what unnerves the market, is Japan which has suffered from deflation since the early 1990s. Before the 90s, the Japanese economy was the envy of the world. Japanese management systems were being copied by corporate America and studied in our prestigious business schools. Why? The Japanese economy seemed invincible. American corporate icons like Firestone were being acquired by Bridgestone (a Japanese company) and “trophy” real estate properties like Rockefeller Center were being purchased by Mitsubishi Estate (also a Japanese company). Then the Japanese bubble burst and Japan has still not recovered – the reason for certain investors’ concerns. Recently, the Federal Reserve Bank and a number of other central banks around the world have taken note of the market’s worries. In a recent speech, Ben S. Bernanke, a new Fed governor, quite clearly outlined that the Federal Reserve is on a watch against deflation and will act even if there are no clear signs of deflation, but simply increasing expectations of deflation. Similarly, the newly designated governor of the Bank of England, Mervyn King, spoke in London on the very same topic. He commented that he was “confident” that the central banks around the world would “do their best” to prevent deflation. So, it would not be too much of a stretch of the imagination to think that central bankers around the world are mindful of this concern and have something of a coordinated plan to offset it. In a speech, Bernanke quite forcefully outlined policy tools which the Fed could use in addition to merely cutting interest rates to ward off a deflationary environment. In his talk he noted that the Fed could buy Treasury bonds, corporates, mortgages, and foreign government debt, making zero interest rate loans to banks and take corporate commercial paper back as collateral. The cost of private credit would go down. Buying foreign government debt would lower the dollar and improve the competitive position of U.S. manufacturers. Some inflation would also be manufactured. The point is simply this: some would argue that with interest rates at generational lows, the Fed has done all it can. We disagree. The Fed still has a number of very powerful options at its disposal and they have been outlined by Fed governor Bernanke. The Fed is at watch on the keep and is ready to use every tool at its disposal in order to prevent deflation.

PREDICTIONS FOR 2003

Fed will not allow deflation

U.S. fiscal & tax policies will be expansive

U.S. economic growth will be at 3%+

Oil prices will drop to low “twenties” per barrel as Iraq & Venezuela get “sorted out”

Japanese yen devaluation will be controlled

Euro will remain strong – at parity to the dollar or better

North Korea will not “explode”

Osama will be “sold out”

Politics in the Middle East will lean to the West

Markets will not be down for a fourth consecutive year (Dare we say this?)

A FINAL THOUGHT

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The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The numbers reported below are derived from sources believed to be reliable, however, we cannot guarantee their accuracy. Past performance does not guarantee future results.

A current copy of our ADV Part II is available upon request or at www.baldwinim.com/disclosure.htm 12/31/2002