The second quarter saw a nice rebound in stocks only for the rally to give up ground the last two weeks of the quarter as the Dow Jones Industrial Average hit new lows and the S&P 500 Index was knocking at the door to new lows. June started off well enough, but then the market again began to focus on the capital needs of struggling financial stocks, notably Lehman Brothers, Wachovia, and eventually government sponsored enterprises (GSE) Fannie Mae and Freddie Mac. Interestingly, broader indices such as the Wilshire 5000 Index and those from Russell remained well above their lows, and the Fund is down half of what it was at the low of the year.

The Japanese Yen trades at 106 to the dollar, up from 98 at its low. The Euro trades at 158, not 160, and two-year Treasury yields are at 2.6%, not 1.4%. Thus, despite the stock of General Motors selling at 1955 levels, consumer sentiment at 18-year lows, the market having its worst June since the 1930s, and that there was not one venture capital sponsored initial public offering during a quarter for the first time in thirty years, there were some bright spots. The Purchasing Manager Index for June was north of 50 and up from May's level of 49.6, thus still not corroborating an economic contraction—at least not yet.

The bottom line is that oil is holding this market hostage, and oil is under the sway of currencies—specifically the strength of the Euro driven by the European Central Bank's (ECB) earlier anti-inflation rhetoric. Given the dramatic softness in the economic numbers coming out of Europe, the decision by the ECB decision to raise rates 25 basis points and tone down their hawkish view was not a surprise, thus allowing the dollar to rally briefly. Unfortunately, with the US government's recent action, and implied put, to support the GSE's any further rally in the dollar is probably out of the question. We need further policy initiatives like reinstating the uptick rule for shorts, raise margin requirements for commodities and the like.

Why are we, as domestic large-growth managers, focused on these macro subjects? This is the environment we are in. Fundamentals have taken a back seat to bank write-downs and oil. During the second quarter, earnings on holdings in the portfolio came in 8% above expectations, and we saw some increases to Wall Street's earnings estimates--though nothing like we would have seen in a more positive environment. Collectively, we have been in the business for 64 years and the last time we saw sentiment this bad was during 1981-1982. Combine that with the current credit crisis and you can throw in the 1990-1991 period on top of that as well.

Focusing on the portfolio for the second quarter, the Technology and Industrials sectors were two of the biggest positive contributors to performance, the former led by the credit card processors Visa and MasterCard. One might remember that these two sectors were the Fund's two worst performing groups during the first quarter of 2008 as the market succumbed to the foregone conclusion that we were in a prolonged economic downturn. The Fund's Energy stake—consisting mainly of domestic natural gas plays where production is growing—now makes up 12% of assets also added positively to returns. We sold US Steel and Freeport-McMoran Copper from the portfolio during the quarter after considerable gains from the Materials giants. In our view, the companies had gone up too far too fast. We also significantly decreased the Fund's exposure to consumer stocks as the dour market sentiment battered most names within the group, detracting from performance. The Fund ended the quarter with a cash position of 15%, though that was simply a function of moving around and not a tactical decision. It is already back down to 10% as we write this, not that a little cash in this environment hurts.

While we would have rather closed the quarter in the middle of June, this is what building a major bottom is all about. Typically, our strategy drops prior to major moves to the downside in the overall market, and holding up well after large sell-offs usually portends a bottoming process. Since the market bottom on March 10, 2008, the Fund has significantly outperformed both its benchmark and the broader Russell 1000 Index through the end of the second quarter. Currently, our proprietary earnings estimates for the Fund's holdings are 22% greater than Street consensus estimates, a level we've never seen before. We believe that disparity reflects the current severe drop in market sentiment—which we believe can be a good thing for active managers, such as ourselves, willing to stick to their process.

Charles P. McCurdy, Jr. CFA, Charles F. Mercer, Jr. CFA, and B. Anthony Weber

As of June 30, 2008, Visa comprised 4.20% of the portfolio's assets and MasterCard 3.40%.