Good afternoon everyone:

Stocks declined approximately 5% for the week.  The main catalyst for Tuesday’s sharp sell off was a dramatic decline in the ISM non manufacturing index (a popular measure of activity in the service sector). A reading below 50 generally correlates with economic contraction. The index value came in at 44.6, which was even lower than the time period following 9/11.

Later in the week, stocks recouped some losses after it was announced the European Central Bank (ECB) was open to lowering interest rates to combat economic weakness (talk about mixed blessings). There is also evidence credit is getting tighter. On a company specific note, Cisco provided a somewhat gloomy forecast.

It is becoming increasingly clear that some level of reduced economic activity is at hand. As forward looking investors however, it is paramount to ask the right question. It is not so important to ask ‘are we going into a recession?’ It is more important to ask ‘to what level do stock prices already reflect the threat of a recession’.

While timing surely isn’t for us and we normally loathe commenting on “the market” (our contribution to the reduction of financial noise pollution) we do offer a few general observations. First, stock prices have already been marked down 15-20% since the October highs.   Technology and financial stocks have fared even worse. Second, the S&P 500 now trades at 14 times 2008 estimates of $97 which is the lowest stated multiple in 10 years. Even by marking down earnings 15% to $82.50, you get a market multiple of approximately 16 times, which appears defendable given the yield on the 10 year Treasury is 3.75%. We realize all the limitations of simple static P/E analysis and the market is by no means out of the woods. However, it does offer some evidence that a good deal of risk is already priced in.

It is more dynamic and robust however, to utilize discounted cash flow analysis. This way, valuation is based on current cash flow, growth of cash flow and the unique risks associated with each company’s cash flow. It yields what a rationale long term investor would pay for an entire business. As a reminder to you, we conduct this analysis on every company in our portfolio, using conservative estimates. Based on today’s prices, our portfolio is nearly 40% undervalued.  The last time we saw an aggregate discount of this magnitude was in 2003, right before stocks moved 50% in 2 years.  As is the case with most big rallies, there was no visible catalyst at the time and most of the news was bad – similar to today. So to reiterate, it’s not so much whether or not the news is good or bad, but to what level the news is reflected in stock prices. Given the level of discount in our portfolio we are poised for appreciation but also hold a built in margin of safety should economic conditions deteriorate.

A few of our companies reported earnings this week.

Like last quarter, Cisco Systems (CSCO) reported strong earnings, but issued some cautious guidance. This is cyclical, not secular. The secular growth story of Cisco absolutely remains in tact. Their products and service solutions continue to be exquisitely positioned right at the epicenter of multi platform, multi geography network convergence. This huge, world wide build-out remains one of the best growth opportunities.  Shares were able to recover after the announcement but were down for the week in sympathy with the market.

Disney (DIS) also reported strong earnings growth across its major platform. We have been saying for some time that CEO Bob Iger’s job is to develop and creatively monetize Disney’s branded premium content across an ever changing and highly complex media landscape (Cable, Internet, Mobile etc). Recent results show his vision is working. Shares rose over 6.0% for the week.

Tyco International (TYC) reported continued progress in restructuring its operations as an independent company. Freed from the conglomerate overhang it will have the ability to right size the capital structure, cut costs and put forth the right initiatives to drive meaningful organic growth. Its undervaluation stems from investors having a ‘show me first’ attitude, but once it becomes evident the turnaround is complete, shares will be much higher.

Thank you. We welcome your comments.

Gerry Mihalick, CFA

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness. Past Performance is no guarantee of future results. A copy of our current ADV II is available upon request.References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities

Good afternoon. Here is an update on an “interesting” week.

After a rough start to the week markets moved up sharply from the lows set Tuesday morning, thanks largely to a 75 basis point rate cut by the Fed and a rebound from very over-sold levels. Good earnings from Microsoft and Honeywell as well as a nice rebound in selected financials are driving solid performance and an increase in values. Through Thursday night, Berkshire equity portfolios were UP (for the WEEK) approximately 3.3% vs. the SP 500’s gain of 2.2%.More…

Big Picture Perspective on Recent Market Activity:

The root causes of the market turmoil stem from poor capital allocation decisions made by investors in the following areas:

1. Abuses in the sub-prime mortgage market
2. Imprudent proliferation of derivative securities created from sub-prime loans
3. Too much leverage in the system: investors, hedge funds, financial institutions
4. Too much speculation in real estate
5. The thought that emerging markets are no more risky than that of the US and other developed markets
1. “Decoupling:” The notion that Asian economies can continue rapid growth while the US falters. This notion has also led investors to the false conclusion that energy and commodity stocks are no longer cyclical.
6. Leveraged Buyouts: What once was the domain of skilled investors who actually built value became a haven for nothing more than corporate “flippers”

What is the common theme? In almost all 6 cases it boils down to a COLLASSAL mis-pricing of risk by investors. They did not adequately asses the risk and did not demand a high enough return for it. The result is prices of risky assets such as stocks, lower quality debt instruments and commodities have moved sharply lower so as to restore the risk/reward profile toward more normal levels.

Diversification:

It is also worth noting, that during this latest correction, it is again apparent that simply owning countless stocks across multiple styles, capitalizations and geographies is not a panacea. History has shown time and time again that correlations (the degree to which stocks move together) rise during times of market panic, and diversification fails precisely when it is needed most. The only way to circumvent intolerable declines is the right mix of high quality bonds or to be short the market.

Outlook:

We do not believe the US equity markets or the economy is permanently impaired. We also do not believe the US financial system is headed for a Japanese style deflationary cycle.

Financial stocks may be in for a rough patch, but there are some positives which justify our continued allocation.

§ Financial institutions have been aggressively writing down bad loans.

§ They are rebuilding their balance sheets with tangible (albeit somewhat expensive) capital. Recapitalizing is the first step to recovery

§ Boards are aggressively implanting stronger management teams. Citigroup, Bear Stearns, Merrill Lynch, Countrywide (via acquisition by Bank of America) have essentially gone through a change in control

§ The profit margin for lending is getting more attractive (via a steeper yield curve)

§ Rate cuts by the Fed

§ Compelling valuation cases can be made for many financial stocks. They are not without risk, but the pay-off is quite high.

While financials have borne the brunt, most of our portfolio has little to do with the latest headlines, the cyclicality of the economy, or the decline in the market. If they do possess a cyclical component, a recession will not likely affect their long term value. Temporary, irrational declines in the likes of DIRECTV, Johnson and Johnson, General Mills, Cisco, Intel or Microsoft (just to name a few) will more likely mean opportunity, not risk.

View of Current Market Psychology:

In the final analysis, its greed and fear that move markets.

Its obvious investors have been “selling risk” (stocks, commodities, high yield bonds) en masse and “buying safety” (US Treasuries). Investors have gone from complacent to extremely fearful. Times of maximum fear and capitulation selling has usually proved a good time to either stay the course or increase commitments to equities. Decades of experience bear this out.

A long term value oriented investor must adhere to the adage: “if it’s in the papers, it’s in the price.” With “24/7” style financial news coverage, blogs, the internet, this has never been more true. Since drama sells air-time, we definitely believe the media can amplify both good and bad economic news. In any event, the problems facing our economy are now well documented, on the table, and now largely discounted in equity prices – perhaps unjustly so.

Finally, while this credit crisis has been a large shock to the system, there have been many seemingly insurmountable challenges to our market and our economy: Cold War, Cuban Missile Crisis, 197o’s Oil Shock, Iran Hostage Crisis, 1987 Stock Market Crash, the Blow up at Long Term Capital, Russian Debt Crisis, Asian Currency Crisis, 9-11, Enron Accounting Scandals, you name it.

At the time, these problems all seemed insurmountable. What’s more these “hundred year floods” seem to occur once or twice a decade. It just comes with the territory of equity market investing and the reward it offers. This volatility is NOT new (yet it never seems to get easier!). We will continue to find ways to use it to your advantage.

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness. Past Performance is no guarantee of future results. A copy of our current ADV II is available upon request.References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities