BCN ADVANTAGE: 2014 ANNUAL REPORT

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For 2014, the S&P 500 climbed 11.4% to 2,059, the Dow gained 7.5% to 17,823 and the Nasdaq rose 13.4% to 4,736. While large-cap stocks had a good year, small and mid-caps stocks moved mostly sideways. As a result, only 8 percent of U.S. diversified stock funds beat the S&P 500 in 2014, returning only 7.9% on average. In 2013, when small-cap stocks were on fire, nearly 62 percent of funds beat the S&P 500. 2014 was a year of U-turns. The major indexes pulled back five times – and threatened to go negative as late as mid-October – before ending the year on a 13% run. It has been more than 3 years since the S&P 500 last saw a correction of 10 percent, the fourth-longest streak on record. Earnings for the S&P 500 ended 2014 nearly 9% below estimates made when the year began. And projected Q4 2015 earnings are exactly flat compared to year-ago estimates. For 2014 overall, the economy grew a moderate 2.4 percent. Since the recession ended in 2009, GDP has averaged 2.2 percent a year, far below the gains typical after a deep recession. Monthly payrolls rose an average 246,000 in 2014, up 27% from 2013. The jobless rate fell to 5.6% (lowest since June 2008), but the drop largely reflected a decline in the labor force, as the participation rate fell to 62.7%, a 34-year low. Only 30 percent of Americans report being better off financially than they were five years ago. Median household income, adjusted for inflation, is about $54,000 today, nearly 5% lower than when the recession began. In 84% of U.S. counties, inflation has outpaced median income since 2007. Fifty million Americans remain below the poverty line, and the number of food stamp recipients have increased 38% in the last six years. Among the emerging risks is the nation’s $1.3 trillion in unpaid student loans. In their mid-2014 report, the Bank for International Settlements (BIS), described “euphoric” financial markets that have become detached from reality. “The trade-off is now between the risk of bringing forward the downward leg of the cycle and that of suffering a bigger bust later on.” The Fed is hoping to achieve liftoff at the same time Europe, China and Japan are likely to keep easing. History shows that sharp movements in foreign exchange result in something breaking somewhere in global markets. There is enough data out there to suggest that U.S. stock markets are toppy: the Q-ratio, corporate equities to GDP (the Buffett Indicator), Shiller CAPE, margin debt. One area that stands out is the corporate bond market. Investors are barely being compensated for the risks they’re taking. In 2007, a three-month certificate of deposit yielded more than junk bonds do today. Why are the markets so worried about Fed rate hikes, especially when the Fed funds rate will likely remain below 1.25% through 2015? Investors and corporations have never before been this leveraged, not even in 2000 or 2007. Total margin debt is fast approaching$500 billion. CEOs have leveraged their balance sheets to repurchase shares.High-grade and junk-rated bond sales exceeded $1 trillion in 2014, allowing corporations to be the major net buyer of U.S. equities. As borrowing costs rise, stock buybacks will be scaled back, undermining a key support for the bull market. Corporate earnings will suffer – from the steady drag of higher interest expense. And no one knows how bond investors will react once the fear of rising interest rates takes hold. If government bonds revert to their yields prior to 2010, 10-year treasuries would plummet 23%. With so much downside risk in treasuries, high-yield debt is even more mispriced.The Fed is expected to begin raising rates in June. Further delay would be a colossal admission of failure. The Fed quadrupled its balance sheet to $4.48 trillion and tripled the duration of its holdings, all unprecedented. If the economy still cannot stand on its own after seven years of zero interest rates and three rounds of quantitative easing, why should we believe Fed policy will ever work? The illusion of central bank control is in full force. Zero interest rates have made investors willing to accept any risk, no matter how extreme, in order to avoid the discomfort of getting nothing at the moment. But what if cash suddenly has the buying power to purchase stocks at 2009 prices? There is a truism in investing: We make our profit when we buy. We do that by investing when market conditions are favorable, and by remaining defensive when market conditions are dangerous. As a result, we protected our clients during the 2000 dot-com implosion and again during the 2008 financial collapse. We moved aggressively back into stocks within days of the market bottoms in October 2002 and March 2009. And we remained 100% invested for all but 5 months prior to going defensive in 2013. So we don’t mind aggressive allocations, as long as the conditions are right. But now is not the time.

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BCN ADVANTAGE: 2013 ANNUAL REPORT

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The S&P 500 rose 29.6% in 2013, its best annual performance since 1997. The Dow climbed 26.5%, its best year since 1995. The Nasdaq soared 38.3%, its best year since 2009. GDP rose 4.1% in Q3 and 3.2% in Q4. 2013 was the best year for IPOs since 2000. A total of 222 companies went public, up 73% from 2012. Since 2014 began, equity markets have been rattled by the outlook for emerging markets, including slower growth in China, while the Federal Reserve continues to withdraw its monetary stimulus. Analysts have already pared Q1 forecasts to 4.5% for earnings and 3.2% for revenue. The Dow fell 5.3% and the S&P 500 lost 3.6% in January – their worst monthly declines since May 2012. The Nasdaq fell 1.7%, its worst month since October 2012. The good news is that growth for the second half of 2013 topped 3.5%. But the improving numbers cannot mask this anemic expansion. The Joint Economic Committee of Congress calculates that if the pace of the recovery over the past 4 ½ years had simply held to the historical average, the economy would be $1.3 trillion larger today. The economy added just 113,000 jobs in January after closing out 2013 by adding only 74,000, the fewest in three years. The unemployment rate fell to 6.6%, the lowest since October 2008. But unemployment has fallen in large part because more than 7 million Americans have left the workforce. The Fed has been forced to end its bond buying program more because of the dangers fraught with its ballooning balance sheet than because of real improvements in the economy. The Federal Reserve’s balance sheet expanded to a record $4 trillion in December from $891 billion in 2007. The Fed now holds $1.5 trillion in mortgage-related assets and $2.2 trillion in Treasuries. At 4 years, 11 months this bull market is already one of the longest since the Great Depression. Looking at the S&P 500 back to 1932, the average bull market duration is 3.8 years. Of 16 bull markets over the past eight decades, only three prior to this one lasted more than 5 years. The S&P 500 has gone 850 calendar days (from October 2011 through January 2014) without a correction of 10% or greater, the 5th longest stretch in the last 50 years.The investing public’s market timing is notoriously bad. And right now, they’re piling into stock mutual funds at the most furious rate in 13-years. Advisors polled by Investors Intelligence reached the lowest percentage of bears since 1987. The percentage of bullish advisors rose to 61.6, the highest in six years. At the October 2007 top, the percentage was 62%. The spread between bulls and bears reached 46.4 percentage points at the beginning of 2014 – for the fifth straight week higher than October 2007. Advisors now have 98.3 percent of their clients’ portfolios allocated to stocks (exposure to equities averaged 72 percent during 2013) and margin debt is at record highs – exceeding $445 billion and far eclipsing 2007 levels. Overall, the S&P, Nasdaq and Dow are simultaneously reaching major trend line resistance in an environment of peak optimism. “Risk increases substantially as the trend ages,” writes Goldman’s chief strategist David Kostin. “The longer the bull market goeson, the higher the excesses become and the more painful the drawdown will be on the other side.” Key metrics indicate stocks are at least 40% overvalued. Record corporate profit margins are the direct result of Federal transfer payments that have continued at emergency levels five years into the economic recovery. Corporations are enjoying stable demand (reflected in flat revenues) without having to hire or pay increasing wages and benefits. So while stock PRICES are merely lofty when compared with current earnings, the danger is that EARNINGS ARE IN A BUBBLE financed by unprecedented monetary and fiscal stimulus. Coming to you in 2014: Higher interest rates, reduced monetary stimulus, reduced fiscal stimulus and reduced discretionary spending (as consumer dollars are redirected toward mandatory health insurance premiums and out-of-pocket deductibles). All the while high paying jobs continue to be replaced with part-time, temporary and contract jobs that pay lower wages or lower benefits or both. Median annual household income has fallen $2,535 since the recession “officially” ended in June 2009 – andthe labor participation rate continues to languish at levels not seen since the 1970s. Each percentage increase in Treasury rates will add $170 billion per year to the interest paid on our national debt. The Eurozone crisis is not over. “The risk of a hard-landing of the Chinese economy is not negligible,” observes Societe Generale. Secular bear markets bottom at P/E multiples below 10x and typically require three major corrections over a period of at least 17 years. If historical relationships hold, we face a concluding 40% to 60% peak-to-trough drawdown that would not be reversed until at least the end of 2016. Our discipline to move to cash (when risks outweigh rewards) allows us to become fully invested after declines (as we did in 2009). It’s worth remembering that prior to our decision to go defensive in early 2013, we remained100% invested in stocks for 30 consecutive months and for all but a handful of months since this rally began in March 2009. These markets are every bit as dangerous as 2000 and 2007. There is no way to sugarcoat it. We are about to enter a period that could be worse than 2008. This time around, stocks, bonds and real estate could all fall in value – perhaps precipitously. In other words, there may be no place to hide other than cash, today’s most despised asset.

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BCN ADVANTAGE: 2012 ANNUAL REPORT

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For 2012, the DJIA closed at 13,104, up 7.3%, the Nasdaq at 3,019, up 15.9% and the S&P 500 at 1,426, up 13.4%. Financials were the strongest industry sector, gaining more than 26%. Of the ten S&P 500 sectors, only utilities ended the year lower, falling 2.9%. Markets tend to do things that confound the greatest number of people. Since 2009, this meant snubbing fretful investors who have persistently bet on a market decline. Individual investors have poured nearly $210 billion into bond funds since the beginning of 2008, while yanking almost $700 billion out of U.S. stocks. In 2012 alone, investors added more than $90 billion to bonds, while pulling more than $150 billion from stocks. Over the last four years, stock investors have endured record daily price swings and three corrections of 10% or more (14 corrections of 5% or more). Daily price swings in the S&P 500 averaged 1.74% in 2008, the most for any year since the Great Depression. Price swings averaged 1.58% in 2009, the third most volatile on record. 2011’s 1.24% average was the seventh most volatile. Average daily price swings fell to 0.59% in 2012. If Congress and the President fail to reach agreement on real fiscal reform, if they raise the debt ceiling while continuing $1 trillion annual deficits, all three major credit rating agencies (S&P, Moody’s, Fitch) may downgrade U.S. debt – and precipitate a credit crisis. A downgrade by all three would compel major bond buyers (such as pensions) to either sell U.S. treasuries or stop buying future treasury debt. $85 billion per month works out to almost exactly $1 trillion a year. A coincidence? In 2012, the Federal Reserve was already the primary buyer for over 70% of newly issued federal debt. If the U.S. continues to run deficits this massive, the Fed has no choice. There is simply not enough money on earth to continue to absorb our mountain of IOUs. The U.S. government will never technically default. But the U.S. can (and will) be perceived as a major credit risk if it plans to pay back its creditors with devalued currency. A spike to 5% in borrowing cost would increase interest payments on our $16 trillion national debt from $250 billion to $700 billion per year. A spike to 7% would increase interest payments to nearly $1 trillion per year, equal to 40% of annual U.S. federal tax receipts. With U.S. treasury yields still near historic lows, market participants are not yet considering and have not priced in the possibility of a significant spike in U.S. treasury rates – despite the consequences already seen in Europe. We are nearing the fourth anniversary of the March 2009 bear-market low, with an unmistakable correlation between “quantitative easing” and the stock-market rally. The Fed quietly began its bond-buying program in late 2008. Since the Fed doubled down in 2009, the S&P 500 has soared 120 percent. By historical standards, the current bull market at 3.8 years of age is exactly the average bull market duration of the past 80 years. Since 1929, the year following a presidential election has been the least profitable – markets have been positive only eight of 15 times, with an average return of 4.7%. And more recessions have started in the first year of a presidential term than in the remaining three years – combined. Fed intervention raises doubts about whether improvements in the economy are sustainable, or merely the result of artificial government support. Today, after $3 trillion in freshly printed dollars, the Fed has likely exhausted – prematurely – its most effective monetary policy to offset fiscal austerity. This does not bode well for 2013.

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BCN ADVANTAGE: 2011 ANNUAL REPORT

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For 2011, the DJIA closed at 12,218, up +5.5%. The Nasdaq closed at 2,605, down -1.8%. The S&P 500 finished exactly where it began the year, closing at 1,258. With all three indexes nearly flat, historians might mistake 2011 for a quiet year – but investors who lived through it know better. On August 8th, the Monday following Standard & Poors’ downgrade of the U.S. credit rating, their namesake index completed its 17% freefall. The markets clawed back half those losses before plunging again – to new lows by the end of September. A classic “demented W” double-bottom had formed, but the roller-coaster ride was just beginning. The S&P 500 was up +17% over 19 trading days from October 3rd through October 28th. Then, on November 1st, Greek Prime Minister George Papandreou shocked the EU – and worldwide markets – with his call for a referendum on the newly proposed bailout deal. European politicians expressed incredulity and dismay. Within days the referendum had been called off (and Papandreou forced to resign), but not before U.S. stocks suffered another 10% decline. Of the 21,000 mutual funds tracked by Morningstar, only 29% beat their benchmarks in 2011 (by contrast, 52% outperformed in 2009, the first year of the market rally). Of the 8,000 funds tracked by Lipper, 92% suffered losses. The average U.S. stock fund lost -2.9% in 2011. Foreign funds performed much worse, losing an average -13.9%. China led all foreign funds down with a -24.0% loss. Japan funds lost -9.8%. Emerging market funds lost an average -20.3%. Europe likely set the stage for the main event: What we can expect in 2013 when the U.S. must begin serious deficit reduction. Austerity does not begin during presidential election years – the federal government will continue to borrow and spend roughly $100 billion per month in 2012, over and above the $200 billion per month we collect and spend from tax revenues. All this spending should continue to lift the U.S. (and world economies) for most of 2012. The average gain for the 28 election years since 1900 is +7.3% (+8.8% if we exclude 2008) and election years with double-digit gains outnumber those with double-digit losses by nearly 3:1. Worth noting, since 1928 there have been six previous years when the S&P 500 finished within 3% of where it started: 1934, 1939, 1953, 1960, 1990, and 1994. According to the Cabot Market Letter: “In the year following a mundane performance, the S&P 500 produced an average gain of 30%, with 5 winning years. The second year out produced a respectable 16% average gain, with four winning years.” Already since Jan 1st, the DJIA has reached its highest close since May 2008. The Nasdaq has climbed more than 10% to its highest close since December 2000. The S&P is up more than 5% but remains below its 52 week high. We need to keep the market’s fast start in perspective: The major indexes have merely returned to their April 2011 highs. Only the DJIA is positive for the 21st century: Since January 1, 2000 (12 years), the S&P is still down -8.4%; the Nasdaq is still down -28.6%. Serious problems remain. The nation has 5.6 million fewer jobs today than when the recession began in December 2007, with 24 million (15.1%) considered underemployed. Case-Shiller data show the housing crash has been larger and faster than during the Great Depression. Prices have fallen 33 percent since the collapse began in mid-2006 and remain near their lows almost six years into the crisis. The national debt recently surpassed $15 trillion and is rapidly approaching the $16.4 trillion debt-ceiling. The debt to GDP ratio has surpassed 100 percent, with the federal government adding $5.5 trillion of new debt (a nearly 60% increase) since 2008. We now owe China $1.132 trillion and Japan $1.038 trillion. This amount of unsustainable borrowing dwarfs what is currently happening in Europe, and must eventually come to an end. My job is to have our clients safely on the sidelines before the effects of real U.S. austerity inevitably take hold.

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BCN ADVANTAGE: 2010 ANNUAL REPORT

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For 2010, the DJIA was up 11.0% (closing at 11,578), the S&P 500 was up 12.8% (closing at 1,258) and the Nasdaq was up 16.9% (closing at 2,653). We endured a wild ride that saw two significant corrections, the first beginning in mid-January, taking the markets down -8.1%, the second beginning in early May, taking the markets down -16%. As late as mid-September, stocks were essentially flat for the year. Finally, in the first week of September, the markets bottomed, with the major indexes reversing and closing out 2010 at multi-year highs. Given the outright destruction wrought by the markets over the past 10 years, few investors were willing to sit tight in early May when the markets began to fall apart. The infamous “flash crash” on 5/6/2010 was initially written off as a technical glitch. In a matter of minutes, the DJIA declined by 600 points (nearly 1000 points on the day) and the stocks of 8 major companies in the S&P 500 fell to one cent per share. Twenty minutes later, the Dow had regained most of the 600 point drop, but the roller coaster ride had barely begun. It is interesting to note that over 21 months, the rally that began in March 2009 has experienced more corrections (declines of at least 5%) than any market rally in decades. Through April 2010, we remained fully invested – even during the January/February decline precipitated by the sovereign debt crisis in Greece (the first of many). We made the decision to exit the markets on 5/19/2010, with the S&P 500 at 1,115. Six weeks later, the major indexes hit their low point for 2010 – a decline of -16% from April and a hairs-breadth away from a full-blown bear market. Following a snap-back rally in July, the markets rolled over again throughout August. The S&P 500 did not regain the 1,115 level until mid-September, 4 months after our decision to go defensive. The indexes did not regain their April levels until early November. Clearly, this was a major market correction. According to their November announcement, the Fed will take 8 months (through June 2011) to inject roughly $100 billion per month into the economy. This is in addition to QE1 – the program initiated in March 2009 (at the very beginning of the current rally) to purchase $1.7 trillion in Treasury and mortgage debt. Quantitative easing of this magnitude is unprecedented, with the Fed essentially creating a huge asset bubble in stocks by printing money. We will likely remain fully invested through the end of April 2011, but possibly longer if economic fundamentals begin to show real (sustainable) improvement. The next major correction (-20% or more) will occur when the Fed is ultimately forced to reverse the money flow and begin taking the $2.5 trillion in monetized debt (printed money) out of the economy. I cannot conceive of any exit strategy where artificially inflated asset prices do not decline precipitously once the Fed reverses course. My job is to have you safely back on the sidelines before that happens. For many reasons, we do not believe the current rally is a new long-term bull market. Corporations cannot grow profits indefinitely by cutting their labor costs. The country faces seemingly intractable unemployment (net 7 million jobs lost since 2008), and ongoing problems with real estate and the debt markets (residential mortgages, along with a new threat from munibonds). The now chronic European sovereign debt “crisis” will continue to flare. And most telling, related to all of the above, is the dearth of initial public offerings. From 2003-2007, new issues averaged more than 200 per year, topping out at 276 in 2007. In the three years since, new issues have totaled just 212 – particularly concerning given that new businesses are the lifeblood of job creation and economic growth. 2010 was a frustrating year, but understanding the ramifications of unprecedented Fed behavior takes time. Our fundamental strategy remains unchanged. The highest priority is to minimize losses – like we did in 2008. The “mathematics of loss” can be unforgiving: A 25% loss requires a 33% gain, just to break even. A 50% loss requires a 100% gain. Because of our outperformance in 2008 and 2009, BCN Advantage clients can profit even in years like 2010, when we missed the September rally.

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BCN ADVANTAGE: 2009 ANNUAL REPORT

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Numerous market records were set during the first decade of the new millennium, including the price of Gold: $1,217.40 December 2009, Oil: $147.27 July 2008, Gasoline: $4.114 July 2008, the Euro: $1.6038 July 2008, the DJIA: 14,165 on October 9, 2007, the S&P 500: 1,565 on October 9, 2007, and the Nasdaq: 5,049 on March 10, 2000. National median home prices reached $226,000 in August 2006. 30-year fixed mortgages (4.71% December 2009) and 10-year Treasury yields (2.06% December 2008) hit record lows. Then there is the record of futility set by the U.S. stock markets. From the close on the last day of trading in December 1999, the DJIA declined 1,069 points (-9.3%), the S&P 500 declined 354 points (-24%), and the Nasdaq declined 1,800 points (-44%). This is the worst performance for stocks in any decade EVER – and yes, that includes the Great Depression. For the decade, the BCN Advantage Actively Managed index enjoyed a +83% GAIN. The Buy & Hold index suffered a 9% loss. That 92% outperformance is directly attributable to tactical market timing. Long-term “secular” BULL markets are easy to recognize. The most recent, from 1982 to 2000, was characterized by an unrelenting upward trend, with only occasional hiccups (like October 1987). Secular BEAR markets are not mirror opposites. Though they match bull markets in duration (typically lasting 15+ years), long-term bear markets are characterized by repeating cycles of declines and rallies. The S&P 500 suffered through 2 major DECLINES during the decade: Over the 2½ years that ended October 9, 2002, the S&P 500 lost 49%. Over the 17 months that ended March 9, 2009, the S&P 500 lost 57%. Conversely, the S&P 500 experienced 2 major RALLIES during the decade: Over the 5 years that began October 9, 2002, the S&P 500 gained +101%. From March 9, 2009 through year-end, the S&P 500 gained +65%. It’s worth noting that the 4 worst total return years for the S&P 500 in the last 75 years took place in 1937, 1974, 2002 and 2008. In the FOLLOWING years, the S&P 500 gained +31.1% in 1938, +37.2% in 1975, +28.7% in 2003, and +26.5% in 2009. The most reliable “crystal ball” is a working knowledge of market history. How else could we anticipate (in January 2009, 8 weeks BEFORE the March bottom) “an 18 to 24 month rally that should take the indexes up 50% or more?” Eventually, the excesses and imbalances in capital, credit and real estate markets will work their way out, but likely NOT before we experience one more wrenching decline (20% or greater). Secular bear markets end when P/E ratios for the major indexes compress below 10. With the S&P 500 at 1115 and 2010 projected earnings at 46, the P/E ratio is currently at 24. Initial public offerings, the life-blood of young bull markets, must re-emerge: Only 12 venture capital backed companies completed an IPO in 2009, and just 18 in the past two years, the lowest total since 1974-75. Finally, what unseen, unanticipated pitfalls could derail the current rally? (1) Lingering high unemployment – above 10%, (2) Heavy-handed regulatory reforms, (3) Tax increases, (4) Defaults on foreign national debt, and (5) Ebbing demand for U.S. Treasury debt. This last point is especially disconcerting. In 2009 ALONE, the Federal deficit was $1.42 Trillion. In October 2009, NET purchases by Foreign governments were $21 Billion (a mere $250 billion annualized). For the record, China, the largest holder of U.S. Treasury securities, maintained its holdings at $798.9 billion in October 2009.

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BCN ADVANTAGE: 2008 ANNUAL REPORT

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We hope the real lesson of 2008 is clear: “Buy-and-Hold” as a reliable strategy in every market does not work. Either you exited stocks early in 2008 – or wish you did. The former is practicing, the latter is aspiring, all are converts. Even Warren Buffett, America’s greatest investor, follows a timing strategy: “A simple rule dictates my buying,” Buffett declared in October 2008: “Be fearful when others are greedy, and be greedy when others are fearful.” Buffett goes on to state he cannot predict short-term movements of the stock market, but does believe “the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up.” He believes this based on his years of experience following market trends, and we cannot disagree. Our ability to predict is limited. Our ability to anticipate based on constantly repeating stock market patterns and trends is boundless. “Losses kill the rate at which capital compounds. Defining risk as the attempt to avoid losses is materially different than trying to avoid underperforming a benchmark. The paradigm of relative returns might soon be perceived as a short blip or ideological error in the evolution of investment management.” (AIMA’s Roadmap to Hedge Funds, November 2008). A hypothetical investment in the 100% Buy & Hold portfolio at the beginning of this decade has suffered a -35% LOSS over 9 years. A hypothetical investment in the BCN Advantage Actively Managed portfolio has enjoyed a +19% GAIN over the same period. The achievement is magnified when you consider the true ramifications of this “Loss Decade.” From the close on the last day of trading in December 1999, the DJIA has declined 2,721 points (-24%), the S&P 500 has declined 566 points (-39%), and the Nasdaq has declined 2,492 points (-61%). In 2009, just to return to those December 1999 levels, the DJIA must gain 31%, the S&P 500 must gain 63%, and the Nasdaq must gain 158%. There is little doubt this first decade of the new millennium will be the worst for stocks – by far – since the 1930s. The nation’s unemployment rate grew to 7.2 percent in December 2008, the highest level in 16 years. For all of 2008, the economy lost 2.6 million jobs, the most since 1945. All told, 11.1 million people were unemployed. The average work week fell to 33.3 hours, the lowest level on records dating to 1964. In addition, 8 million people were working part time. The country is battling a housing collapse, a lending freeze and the worst financial crisis since the 1930s, making the current downturn especially dangerous. Even with new government stimulus and the Federal Reserve ratcheting rates down to nearly zero (an all-time low), unemployment is expected to hit 9 or 10 percent by the end of 2009. Even then, unemployment would just begin to match the levels seen in the last consumer-driven recession of 1980-82. We doubt the TARP’s true aim was ever to get banks lending again. The real effort was to avoid “counterparty” defaults in the huge over-the-counter marketplace for debt derivatives. $62 trillion of credit-default swaps (at its height, compared with a $21 trillion U.S. residential real estate market), was too great to permit a domino effect. The Lehman Brother’s bankruptcy – the real catalyst for the cascading market decline that began in October 2008 – proved the banks and insurance companies were too big to fail. Attempts to stabilize real estate have been largely unsuccessful. Too much air was contained in the over-inflated housing balloon. From 2004-2007, mortgage equity withdrawals (MEWs) exceeded $500 billion per year – money that was pumped directly into the economy, adding 2-3% to annual GDP. Residential real estate will stabilize when prices return to affordable levels – naturally. Until then, mortgage “work-outs” will continue to lead to re-default, and foreclosure moratoriums will be counter-productive. The housing bubble burst with unemployment at historically low levels (4.5%). Is there any wonder that defaults and foreclosures continue to skyrocket now that unemployment is soaring? We will know that housing has stabilized when the inventory of unsold homes falls below 6 months (supply is currently over 11 months). If we cannot stabilize housing – or more specifically, restore MEW to previous lofty levels – then attention must focus on job creation. This will be the essence of Obama’s economic stimulus plan – the adrenaline injection that will spark the next market rally, however short-lived. Likely we will go through at least one more cycle, the “Camel Hump,” that lasts from 4 to 6 years: First, we must endure the Q4 2008 earnings season to absorb what should be the worst quarter for earnings this decade. Second, we will see the market reaction to Obama’s economic plan: an 18 to 24 month rally that should take the indexes up 50% or more.

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BCN ADVANTAGE: 2007 ANNUAL REPORT

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Last year’s annual report ended with a question: “Is this 1995-1999 all over again, the last time the Fed ended a series of interest rate hikes? Or will the markets finally surrender to historical precedent? Our job is to identify the real trend – early – ahead of the crowd.” Well, we were certainly “ahead of the crowd.” This is by far the most defensive we have ever been, and the longest period we have gone without a market move. But the key question has finally been answered: The DJIA has declined 2,065 points (-15%) from its Oct 9th 2007 closing high of 14,164.53. The S&P 500 has declined 240 points (-15%) from its Oct 9th 2007 closing high of 1,565.15. And the Nasdaq has declined 519 points (-18%) from its Oct 31st 2007 closing high of 2,859.12. Our interim reports didn’t just say the markets were due for a correction. We declared flatly that this is the “highest risk market we have seen since Q1 2000.” In 2007, the markets experienced severe downturns in February, August and November. The first was the “carry-trade” shakeout, which lasted just a month. The August meltdown was much worse, when “sub-prime” fears finally went mainstream. At the mid-August low, just 30% of stocks stood above their key 200-day moving averages – the lowest reading since October 2002. Many analysts believed the August correction had formed a major market BOTTOM; that problems stemming from the mortgage crisis and ensuing credit crisis were now fully “priced in.” We strongly disagreed. Emergency action by the Fed (3 rate cuts amounting to a full percentage point), an announced sub-prime bailout by Treasury, and understated “write-downs” by the major banks stopped the bleeding, but only temporarily, and only enough to cloud the investment horizon. In what will go down as our best decision of 2007, we firmly resolved to “Fight the Fed” – a decision that was met with more than a little frustration. History was certainly against us: only two other times have the markets dropped more than 10% in the six months after a 3rd Fed rate cut – once in 1930, during the Great Depression, and again in 2001, when the dot-com bubble burst. In both cases, the rate cuts failed to cushion the economy from a recession that was already underway. The outcome for many investors will be the “dark-side” of Federal Reserve intervention: a severe whipsaw that saw them chase artificial gains through October, only to see the collapse begin in November once the fundamental rifts in our economy began to take hold. Having already experienced short-lived declines in February and August, selling early into the November decline would defy human nature. This is how markets work so deliberately to separate investors from their money. The closing highs achieved by the DJIA, S&P 500 and Nasdaq in October 2007 most likely formed a long-term market top. If historical precedents hold, we will not regain those highs for 12-18 months. Consequently, the decline that began in early November 2007 is the beginning of a relatively severe bear market that, at the very least, should return the indexes to their 2006 lows: 10,700 for the DJIA, 1,230 for the S&P 500, and 2,020 for the Nasdaq. Despite the gloom, there are good reasons for encouragement. We are once again fully in sync with the markets, and we will remain in sync (much has been learned over the last 12 months). We are never hesitant to call significant turning points: the market top in this report, and the October 2002 market bottom (way back in January 2003), when most investors were still heading for the exits. BCN Advantage clients are now positioned to take advantage of the coming capitulation and washout – because we have patiently and steadfastly maintained our cash reserves.

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BCN ADVANTAGE: 2006 ANNUAL REPORT

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We are in the late stages of a 4-year bull cycle that began in October 2002. This is the 5th longest bull market in the past 75 years. This is the 2nd longest period in the history of the S&P 500 without a 10% correction. And this is now the longest period in over 107 years without a 2% intraday decline in the DJIA. The late stages of any cycle (whether bull or bear) are always the most difficult to navigate, because we must act CONTRARY to the crowd. When everything looks rosy and complacency runs rampant, beware: a major decline is usually around the corner. “Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival,” wrote Gerald Loeb, the legendary stock trader who sold just prior to the Crash of 1929. Loeb argued that investors should not buy until the profit possibilities greatly outweigh the risks. We could not agree more. All major bull markets (such as the long secular bull run from 1982 – 2000) are followed by long periods of consolidation, typically lasting a decade or more. As we emphasized back in January 2003: “likely now is a pattern similar to the one we experienced from 1966 through 1982, when the Dow spent 16 long years butting its head against the ceiling at 1000, in the process going through repeated cyclical bull and bear markets.” This channel theory is central to our overall investment strategy. If the markets hold true to their historical norms, then the DJIA should be forming a channel roughly from 12,000 to a low of 7,200. (Since 2000 – seven years). The Nasdaq should form a channel roughly from 2,400 to 1,400. (Since 2001 – six years). And the S&P 500 should form a channel roughly from 1,400 to 850. (Since 2001 – six years). If the indexes hold to their historical norms, declines of 20% to 40% should come as no surprise. The four horsemen? The U.S. housing market is now in uncharted territory. The 3.6% decline in median sales prices marked the first yearly decline in home prices since the Great Depression. But the real key to housing is the effect declining (or simply flat) real estate values may have on the consumer. All cycles essentially fuel themselves, and this one has been no different: so long as their home prices rose, consumers (whose spending now comprises more than 70% of annual GDP) could borrow against equity and continue to spend; with consumer spending strong, corporate profits could continue to rise (with 13 consecutive quarters of double-digit earnings growth); with stock prices on the rise, companies could use their stock to buy other companies (2006 saw near record activity in IPO’s and leveraged buyouts). But this cycle has been fueled almost entirely by debt. After 17 consecutive rate hikes, lifting the Fed Funds rate from 1% to 5.25%, has the Fed taken away the punch bowl? Over the last 50 years the Fed has made a series of tightening moves 10 prior times: 8 have led to recessions and 9 to bear markets. “Significantly, in all 9 instances where the Fed tightened and the yield spread dropped below 50 basis points, a bear market followed…” The yield curve is now technically inverted, with the short-term Fed Funds rate more than 50 basis points HIGHER than the 10-Year Treasury Constant Maturity Rate. In each of the four previous instances where short-term rates have exceeded long-term rates, a recession has followed soon afterwards. The Fed ended its 2-year series of interest rate hikes on June 29, 2006. Two weeks later, on July 14, 2006, oil peaked at $77 per barrel and began a precipitous slide that has seen the price of oil fall by 35%. These two events do much to explain the sudden reversal in the stock market – from severe correction to the mostly uninterrupted bull run that began in mid-August. Much like the inverted yield curve, oil may be forecasting an ominous outcome: a U.S. (and global economy) on the verge of a major slowdown.

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BCN ADVANTAGE: 2005 ANNUAL REPORT

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For the major market indexes, 2005 was a roller-coaster ride in the truest sense – peaks and dips and rolls that ultimately ended (almost exactly) where the ride began. The DJIA finished -0.61%, the S&P 500 +3.0%, and the Nasdaq +1.4%. The ride was anything but smooth. The Nasdaq staggered through 4 major swings: -13% from January to May; +16% from May to August; -8% from August to mid-October; and +8% from mid-October to December. The Nasdaq began the first 3 weeks of January by selling off 7%. After a brief bounce in February, when we made our only move of 2005 – to 60% cash on February 22nd – the Nasdaq continued its rapid decent, all the way down to 1904 on April 28th. Though this proved the low for year, it wasn’t close to the end of the ride. After climbing back to 2209 by August 3rd, the Nasdaq began another steep slide, this time to 2037 on October 12th. Then, powered by a record 14th consecutive quarter of double-digit earnings, the market reversed again, finishing the year at 2205. Our gains over the past year give us sufficient cushion to move fully into this market, which is beginning to resemble 1995-1999, the last time the Fed ended a cycle of sustained interest rate hikes. The major indexes have broken through key resistance levels and the economy appears to be firing on all cylinders – with earnings, employment, GDP and productivity all robust. But we are proceeding with trepidation, because we know full well the underlying risks. The Fed appears to be nearing the end of its tightening cycle, with the markets expecting only 2 more rate hikes ending with the March 28th FOMC meeting. Any Fed action beyond that will be viewed with great pessimism. Unless the $8.2 trillion Federal debt ceiling is raised by mid-March, the U.S. “will be unable to continue to finance government operations,” wrote Treasury Secretary John Snow, in a recent letter to Congress. The debt ceiling, of course, will be raised (it’s been raised more than 70 times in the last 50 years). Unfortunately, the collateral damage in the face of our immense national debt (which equals roughly $27,000 per man, woman and child in the country) could be severe: the most notable casualty may well be the refusal of Congress to renew (much less make permanent) the 15% tax on capital gains and dividends. This too would be viewed with great pessimism. Finally, this cyclical bull market that began in March 2003 is now in its 34th month, already beyond the historical average of 30 months (for the 15 bull markets over the past 75 years). Whether conditions more closely resemble the summer of 1999 or the spring of 2000 makes a very real difference, and the economic data clearly favor a more optimistic outlook – at least for now. If we are nearing the end of this current bull run, the gains over these final months could be substantial – hence our decision to become fully invested. But when the markets turn, be prepared: We will move to the sidelines at the first sign of trouble.

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