PERIOD FMR* Taxable S&P 500 DOW JONES Nasdaq
1st Qtr 5.62% (1.29%) (.92%) 2.17%
2nd Qtr .74 1.30 .75 (0.001)
YTD 6.40 2.60 (0.18) (2.16)
Six months ago we estimated that the total return of the S&P 500 in 2004 would probably fall in a 10-15% range. As you can see, the six-month data by the S&P is a far cry from that annual rate. After the huge 25% gains in the S&P 500 last year, with 92% of all stocks up for the year, we did not expect a repeat performance but a very subdued year of consolidation. Our belief is that the probability of stronger than expected stock prices in the second half of this year is high because the rate of corporate profit growth and dividend increases will continue to be surprisingly strong. This is possible because of the strong economy (GDP +4%), near record consumer sentiment, improved pricing power by corporations, strong export growth because of the weak dollar, and importantly, nearly every corporate executive, for fear of litigation, is forecasting profit growth too conservatively. In addition to strong profits, many of the other investment issues important to stock prices are becoming either benign or outright positive. Core inflation appears to reside around 2% and will be less of a prompt for Fed tightening than is currently discounted. Presently, the futures markets are ‘pricing-in’ an expected 175 basis point increase in short rates over the next year. The market has been overly worried about rising interest rates for the past three months with a belief that stocks are worth less. While it is true that price earnings multiples on the market have come down markedly since 2000 (17x in 2004 vs. 35x in July 1999), historically the average company’s earnings have grown faster when there is moderately rising inflation. With inflation between 2-3%, price earnings ratios of 17x-18x for the market are normal. Stocks are an excellent inflation hedge in a moderately rising inflation and interest rate environment, which is what we are now experiencing. Although financial markets have acquired a manic fear of inflation, there are a number of reasons inflation will remain quiescent: commodity prices appear to have peaked and are turning down; China’s torrid growth has finally slowed; US productivity has remained strong; and bond prices already reflect a normal tightening of short-term interest rates (the ten year note peaked at 4.88%, up from the recent low of 3.68% on March 17, 2004 and is currently yielding 4.45%). While Iraq and presidential election spats will continue to nag the markets, these are not new issues and they are likely to look less lethal in scale by the end of the year.

Five Mile River performance at the half way mark this year is on target with our modest expectations of a +10% year following the big year in 2003. Most portfolios are up in the +5% range for the year after weathering significant corrections in our interest rate sensitive investments this Spring. We are very comfortable that our conservative total return approach will produce returns 8% over the core rate of inflation. The outlook for our real estate investment trusts, utilities, and master limited partnerships is excellent. These investment vehicles are businesses focused on natural resources such as oil and gas, as well as, coal and timber that distribute the majority of their income as real growing dividends. In the MLP’s, most of this income is sheltered as return of capital. This asset oriented core group of investments provides a low volatility base of growing dividend streams paid out quarterly in real cash to you as shareholders and provides an excellent hedge against moderately rising inflation.

A second newer theme for the Five Mile River portfolios in 2004 has been a gradual but steady portfolio repositioning to large cap quality companies such as Federal Express, General Electric, Microsoft, and JP Morgan Chase. We feel this shift is prudent for the following three reasons: One, geographic and product diversification perform better (more stable) than many single product smaller companies in a gradual slow down of the economy, which we expect in 2005; Two, strong business models with strong balance sheets allow these companies to withstand rising interest rates better than smaller companies; Three, growing dividends come from larger companies because they have stronger free cash flow than smaller companies and more consistent earnings over economic cycles. We anticipate a 10% long-term outlook for stock market returns. Remember that for the past 78 years 41% of the S&P 500’s total return came from dividends. The overlay on this strategy will continue to focus on business models that are selling at a discount to either their asset value or enterprise value another buyer would be willing to pay. Many of these larger companies are undervalued growth models with significantly higher three year earning power from product repositioning, restructuring, new management, and strategic acquisitions (Kinko’s by Federal Express). Finally, we will continue to look for and invest in special situation value plays like spin-offs such as Hospira (hospital product supplies from Abbott Laboratories) and MGM (largest film library with sale of company for value of this library expected in second half of the year).

Some housekeeping news, we are delighted to welcome Colleen Bucknum as our new office manager. She arrived from Andor Capital, another hedge fund located in Stamford, CT. We are also pleased to report that we have opened our new offices at 100 First Stamford Place, 6th Floor East, Stamford, CT 06902(Robbins Capital Partners 203-388-4848 and Five Mile River 203-388-4810). Both moves are anticipated to help us manage continued consistent growth.

As a registered investment advisor, we are required annually to send our investors a copy of our privacy policy, which is enclosed with this mailing. In addition we will be glad to furnish, upon request, copies of our ADV filings Part I and Part II, our proxy voting policy, or our code of ethics. We are delighted to welcome so many new investors and we thank you for your continued support.


Sincerely,

Lee Garcia - Managing Member

Todd Robbins - Managing Member

* Results are net of management fees and are not audited.

DISCLAIMER

This letter is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendation concerning the manner in which any client’s accounts should or would be handled as appropriate investment decisions depend upon the client’s investment objectives. Any offer to sell or the solicitation of an offer to buy any interests in any securities may be made only by means of delivery of a Five Mile River Investment Management Agreement and or other similar materials which contain a description of the material terms and various considerations and risk factors relating to such securities. Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client’s or prospective client’s portfolio, and there can be no assurance that investors will not incur losses.