BCN ADVANTAGE: 2004 ANNUAL REPORT

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Measured from the October 2002 low, the current bull market is now 26 months old. How have BCN Advantage clients faired? First, it’s important to remember our very accurate evaluation at the time: “Despite the looming war and dismal economic news, our confidence is growing. We believe the October 2002 lows will prove to be the bottom of this historic bear market.” (BCN Advantage 2002 Annual Report) We translated that analysis into action, moving our clients 100% into the market in mid-August 2002. We moved to cash ahead of the war, but our indicators turned so strongly positive in mid-April 2003 that we moved 60% into the market BEFORE the end of “major military operations” and 100% into the market by the end of May, long before conventional wisdom recognized this current bull phase. The Nasdaq stood at 1472, the DJIA at 8454 and the S&P 500 at 916. The first 9 months of 2004 were characterized for the most part by a consolidation phase (more about this in a moment), but the market did display some very disturbing behavior: the Nasdaq fell from its January 26th high of 2154 to its August 12th low of 1752, a decline of 19%. BCN Advantage clients were largely out of way, because we moved 60% to CASH on April 29th. Through late summer and early fall, the markets gave so many head-fakes and false signals that our October 4th move 100% into the market was greeted by several howls of protest. With the election still three weeks away (and too close to call, making a Florida repeat likely) and oil at $55 a barrel, the emails and phone calls were non-stop. The Nasdaq stood at 1942, the DJIA at 10,192 and the S& P 500 at 1131. Today’s 2.2 year-old bull market compares with an average length of 2.6 years for the 15 bull markets that have occurred over the past 75 years. So one could hardly call this a “young” bull market, and we have to evaluate very carefully the key factors that could propel (or derail) this bull phase in the coming months. The Fed began its current round of rate increases on June 30, 2004, and to date has completed 5 “measured” rate hikes of ¼ point each, bringing the federal funds rate to 2.25%. Historically, interest rate hikes take six months to sink their teeth into corporate earnings and precipitate a market decline… just about where we are right now. But remember, we are coming off the lowest interest rates since 1961. The Fed moves – so far – have brought short term rates roughly even with annual inflation (a neutral stance) and have barely budged 5 and 10 year rates. Oil above $40 a barrel will remain a drag on the economy and could severely limit stock market gains during 2005. On the other hand, high oil prices, because they impact the economy in much the same way as high interest rates, could provide the Fed with the justification to keep interest rates low – or at least to keep future rate hikes “measured.” Keep in mind that market breakouts and big new up trends NEVER begin in perfect, worry-free environments. Oil speculation and concern over future interest rates have all the hallmarks of the “wall-of-worry” that markets like to CLIMB. 2004 provided a reminder of the importance of global diversification. Of the 23 stock markets around the globe, the United States lagged all but four. Factoring in currency gains, the U.S. market came in dead last, because of the declining dollar.

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BCN ADVANTAGE: 2003 ANNUAL REPORT

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On May 1st, standing on the deck of an aircraft carrier streaming through the Atlantic, President Bush declared an end to “major military operations” in Iraq. If you were a BCN Advantage client, your money was already 60% invested in the stock market, long before conventional wisdom recognized this current bull phase. The Nasdaq stood at 1472, the DJIA at 8454 and the S&P 500 at 916. Our decision to move back into the market in April 2003 will rank as one of our best calls ever… based not on luck, intuition or any other “gut feelings,” but on time-tested market indicators. The markets had seen their lows in October 2002 – we stated that flatly more than a year ago. BCN Advantage clients were fully invested coming off those lows, prudently in cash while we side-stepped the war, and once again fully invested by the end of May 2003. This marks the seventh year of the BCN Advantage service, in what has truly been a trial by fire. We have navigated through 1999, one of the best years in stock market history, through a 3-year bear market that saw, at its lows, the Nasdaq implode 78.4% from its March 2000 high, and now through this cyclical rebound of 2003. How have we fared? Since the beginning of 1999, BCN Advantage clients are up an average of 42.5%. By the same measure, passive “buy-and-hold” would have gained merely 10.2%. From our all-time index high of $260,127 achieved at the end of 1999 (before the “bubble burst”), we are off 13.2%. This with the Nasdaq still nearly 60% below its all-time high. That’s pretty darn good shooting. These are the results of more than market timing, but also excellent fund selection, allowing BCN Advantage clients to generally equal or exceed the S&P 500 – while remaining over 30% in cash for most of 2003. Don’t overlook the value of fund selection… a vital component of the BCN Advantage service. The critical question now: how much upside is remaining in this market? In last year’s annual report, we explained the high probability that the markets are now in long-term trading CHANNELS. Every post-mania market for the last 75 years has formed a similar channel: DJIA 1932 – 1950, DJIA 1966 – 1982, Nikkei 1989 – present, DJIA 1999 – present, Nasdaq 2001 – present. The DJIA is already 5 years into its trading channel, so we have a good handle on its likely tops and bottoms. The Nasdaq is just getting started, and consequently is much more difficult to navigate. But if historical patterns hold, the analysis we do today could serve our clients well for the next decade! Let me quote this warning, courtesy of Comstock Partners: “The market remains highly overvalued on every metric we use. Over a long period of time, the S&P 500 has sold at an average P/E multiple of about 15 with a range prior to the late 1990s between 22 at peaks and 7 at lows. The average P/E at cyclical bottoms in the post-war period has been about 11. Currently the index is selling at 23 times the consensus estimate for 2003 reported earnings. This means that if the S&P 500 declined only to its historical average, we would be looking at a drop of 35%. It is far more likely, however, that the next major decline would carry the index closer to its more typical major low of 11 times earnings, which would result in an overall drop of 52%. The S&P 500 is similarly overvalued on the basis of dividend yield, price-to-book value and price-to-sales. “It is virtually inconceivable that one of the greatest financial and economic bubbles in history was cured by the relatively mild recession that followed. In fact, a far deeper decline was averted only by an unprecedented policy of massive stimulus including 13 FOMC interest rate cuts, three major federal tax reductions, hundreds of billions of dollars of cash-outs on mortgage refinancing and a 33 percent drop in the dollar. This stimulus won’t be repeated in coming quarters, and we have grave doubts that the economy can sustain itself on its own. These moves have temporarily bailed out the economy, but have failed to correct serious structural imbalances that will come back to haunt us. These include the massive U.S. trade imbalance, record debt relative to GDP, a low consumer savings rate, and a major Federal budget deficit.”

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BCN ADVANTAGE: 2002 ANNUAL REPORT

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The market has been so bad for so long, the numbers read like a history lesson: The Nasdaq fell 39.3% in 2000, 21.1% in 2001, and 31.5% in 2002. At the October 2002 bottom, the Nasdaq had imploded 78.4% from its March 2000 high, a depth and duration second only to the Dow’s collapse of 89.5% from 1929-1932. To add even more perspective, only 4 times in the past 170 years have the market averages declined for three consecutive years, the last occurring from 1939-1941. Half of the top 10 bankruptcies of all time have happened since late 2001. Behemoth energy trader Enron filed for Chapter 11 in December 2001, and was soon followed by fiber-optic firm Global Crossing and discount retailer Kmart. In January, Arthur Andersen admitted to document shredding, but by March the market began to rally, believing that incidents of corporate malfeasance and accounting fraud might be limited to Enron. Then came the SEC investigation of WorldCom, culminating in the telecom company’s restatement of $3.8 billion in falsified earnings and filing for bankruptcy protection. Seeing companies collapse is one thing. But when the public saw CEOs willfully betraying investor trust, they began to lose faith in the market. From the high of 2055 on January 8th, the Nasdaq fell all the way to 1114 on October 9th. In the face of this brutal bear market, the importance of the BCN Advantage service could not be more evident. Once again we outperformed a passive “buy & hold” strategy by a substantial margin: 9.48% in 2002. For the entire 3 year period, we have outperformed “buy & hold” by a cumulative 29.16%. For every $100,000 under BCN management from 2000-2002, that’s $29,160 of losses avoided. One misstep was the March 4th decision to move 60% into the market, but we could not know the WorldCom debacle was lurking just 9 days around the corner! And to our credit, we avoided the panic selling in October because we understood the significance of the market’s double-bottom. “The heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity,” Greenspan said in February 2003. The problem is more than psychological. Companies have cut earnings guidance as their customers delay orders, and much of the recent U.S. economic data is bleak: First-time jobless claims continue to hold above the key 400,000 mark. Consumer confidence fell to the lowest level in a decade. Manufacturing turned negative, housing starts fell, and retail sales slid as high gasoline prices cut into consumption. Analysts caution that anything less than an optimal outcome to the war could disrupt the U.S. and possibly global economy, especially if Iraqi forces sabotage oil fields as they did in the 1991 conflict. The Federal Reserve continues to hold interest rates at 1961 lows, contending that uncertainties caused by war with Iraq are so extreme the FMOC cannot gauge the economy’s prospects. Said Greenspan: “the committee does not believe it can usefully characterize the current balance of risks.” His comments are curious, given the nearly universal consensus that the 1991 Gulf War provides a blueprint: From January 15, 1991 (on the eve of the Gulf War) until February 28, 1991 (the cease-fire), the Nasdaq gained 27%. Once again, if the war is quick, this time ousting Hussein, destroying his weapons of mass destruction, and liberating jubilant Iraqis (with few casualties), the expectations run high. But how long will the market’s euphoria last, especially with quarterly earnings just around the corner? Like Greenspan, we don’t know – and we are not in the business of guessing. “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, a legendary stock trader who sold most of his holdings just prior to the Crash of 1929. Loeb argued that investors should not buy until the profit possibilities greatly outweighed the risks. A major part of his analysis focused on assessing (not predicting) the prevailing market trend. And right now the overall trend continues to be bearish.

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BCN ADVANTAGE: 2001 ANNUAL REPORT

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We are, to say the least, extremely pleased with our 2001 performance. In the throes of a brutal bear market, we outperformed a passive buy & hold strategy by an impressive 16.46%. Even a 50% cash position did not defend you as well as the BCN advantage service. We must admit, upfront, that the events of September 11th skewed the numbers more than little. Our clients were fortunate to be in cash prior to acts that no one could predict. Yet to our credit, the June 15th alert had already proved correct several weeks prior to that day. Here are 2 observations about the year we’ve just weathered: The value of experience – or more specifically, the importance of learning from your mistakes – cannot be overestimated. After nearly 2 decades of analyzing the stock market, the most important lesson I’ve learned is simply this: When it comes to investing, do what makes you feel the most uncomfortable. If we’re going to let our emotions guide us – then be contrarian – and do exactly the opposite of what they tell us to do. It’s an incredibly difficult lesson to learn – and apply. In the 5 years that we’ve offered the BCN Advantage service to our clients, we’ve only failed to heed this lesson once, and the result was our 9/8/2000 decision not to exit the market. With experience, you CAN sift though the mountains of information, read and trust your indicators, and set aside the conflicting emotions when the time comes to act. The value of active management – or more specifically, the importance of the BCN Advantage service – is just beginning to be appreciated. Counting the dollars is easy: For a client who had $100,000 invested last year, our service paid for itself for the next 30 years. Counting the intangibles is more difficult – but just as important: A change in investment philosophy is underway, and you’re far ahead of the crowd. Active management will become as predominate in the 21st century as passive buy & hold was in the last. And the change springs from the power of information. When “modern” portfolio theory was developed in the 1950s, only the major brokerage houses and Wall Street bankers had access to objective, accurate, timely information. In the absence of such information, it is impossible to make informed investment decisions. The only defense is to make NO decision – which, when you think about it – is really what passive buy & hold investing became. What’s changed (as recently as the last 10 years) and with implications just beginning to become clear – is the quality and speed of the available information. And like any other area of human endeavor, investing is no different: Information is key – and those who devote themselves to understanding that information gain substantial advantage.

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BCN ADVANTAGE: 2000 ANNUAL REPORT

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No, we are not happy with our 2000 performance. But before we get to the missteps, here’s a quick look at what we got right: We correctly predicted the demise of the Internet startups: “the bust will inevitably follow. We expect fully 80% of today’s high-flyers to fall by the wayside.” [BCN Advantage 1999 Annual Report.] We successfully avoided much of the March-April decline. Where possible, we positioned our clients in mid-cap stocks, one of the year’s best performing groups. This limited the downside and demonstrates that fund selection (not just market timing) is a major component of the BCN service. We moved fully into the market following the March-April decline, taking advantage of the climb back to Nasdaq 4200 that ended in late August. But… missing the September exit signal more than offset the gains from the first 8 months of the year. Mistake #1: Thinking our key market indicators had been distorted by the uncertainty surrounding the presidential election. Markets hate uncertainty and the outcome of this presidential race was the most uncertain in our nation’s history. But the noise from the election should have been dismissed, not our key indicators. Mistake #2: Thinking the market’s March-April decline had already priced in the 1/2-point Fed hike of May 16th. The market does not do a good job of anticipating (and pricing in) Federal Reserve interest rate moves. Instead the market tends to react to Fed moves after the fact. The best evidence was the market action leading up to the Jan 3rd rate cut. The closely watched Fed futures precisely predicted that (1) the Fed would cut; (2) the Fed would cut ½ point (rather than the ¼ point many analysts expected); and (3) the Fed would cut between scheduled meetings (rather than waiting for the next FOMC meeting on Jan 31st). Despite being right on all counts, the market continued to sell off heavily right up to the Fed’s “surprise” move. For the record, this is more than just hindsight – these are invaluable lessons for the future. Don’t Fight the Fed. Sure, we know that… but what does this mean when it comes to your money? The first half of the equation is straightforward: when the Fed CUTS rates, it’s time to move fully into the market. The Fed almost always cuts interest rates when economic conditions are at their worst. Though it often takes more than one rate cut to fully reverse the market’s decline, waiting for an absolute bottom is rarely worthwhile. Remember the market’s dramatic reversal after the Fed cut rates in October 1998, in the face of the international currency crisis? We didn’t wait. We moved our clients back into the market and remained fully invested through most of 1999, a record setting year. Okay, so what steps should we take when the Fed RAISES rates? Our analysis shows that it’s almost always a mistake to move instantly to cash when the Fed begins a series of interest rate hikes. The Fed raises rates when it perceives “unsustainable growth”: the economy is overheated and growing too fast. In other words, the Fed begins to raise interest rates at precisely the moment when economic conditions are at their best. Historically, interest rate hikes take six months to sink their teeth into corporate earnings and precipitate a market decline. So… when the Fed begins a series of interest rate hikes, it’s important to remain in the market until the first clear sign of trouble. Our job is to spot the warning signs. If we miss a signal or misread our indicators, we know from long experience that the worst reaction is to sell into the decline. Our job is to get our clients out BEFORE the market heads south, not after the damage is done. Downturns become a BUYING opportunity, and not a time for panic selling.

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BCN ADVANTAGE: 1999 ANNUAL REPORT

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On the heels of an international currency crisis, unprecedented market volatility, Federal Reserve rate hikes and Y2K fears, 1999 saw just about the best performing year in market history. It will remain a classic example of Wall Street climbing a “wall of worry.” To demonstrate our value, we ask for an honest answer to this one question: on your own, would you have remained fully invested right through the popping champagne corks of midnight 2000? BCN Advantage clients did, and we are very proud of our 1999 performance. But that’s yesterday. What in the world is happening now… or tomorrow for that matter? The benefits of the Internet to the consumer will be dazzling. Convenient access to all manner of goods and services at the best available price will change our lives. But for business, well… after spending billions to build-out their Internet infrastructures, corporations will discover that fierce competition – and easy access to information – will make earning actual profits extremely difficult. The Internet is nothing less than a gold rush. In 1849 those selling the picks, the shovels, the denim jeans (the equipment suppliers like our modern day Cisco) made a ton of money. But the bust will inevitably follow. We expect fully 80% of today’s high-flyers to fall by the wayside. We’ve heard the phrase “New Economy vs. Old Economy.” This is a feeble attempt to explain the soaring share prices on the Nasdaq while the Dow Industrials and S&P 500 lag. What strikes me as remarkable is that 18 months ago, the prevailing wisdom had all your money going into S&P 500 Index funds (yes, those same Old Economy stocks). What these gurus forget is that “Old” buys what “New” sells, and if the Old Economy companies falter, the new ones won’t be far behind. The real cause of this historic divergence is straightforward: investors are selling the perceived laggards to buy the high-flyers. Traditional 401k, 457 and IRA contributions, sources sufficient to fuel the markets at lower levels, simply aren’t enough anymore. This trend is usually the precursor to major market tops. Eventually those beaten down S&P 500 and Dow stocks reach levels too attractive to sell. Buyers run out of money to buy the “New Economy” stocks at their stratospheric prices, and the high-flyers plunge from their own weight. If the idea that higher productivity causes inflation makes no sense to you… you’re not alone. We suspect Greenspan’s “wealth effect” is really a smoke screen. Greenspan knows where inflation is… in stock and real estate prices… and yes he’s worried about a stock market bubble. But Greenspan has remarkable faith in free markets. Perhaps his real worry is what happens when Congress begins spending the billions of dollars in projected budgets surpluses over the next decade. Clinton has already proposed adding prescription drugs to Medicare. When the federal government subsidizes demand without affecting supply, you get inflation… big time. Want another example: look what’s happened to college tuition costs. Have all those federal grants and loans made college any more affordable to your family? A hand-full of companies (65 stocks accounted for 99% of last year’s gains) moving the Nasdaq to record highs. Add an inverted yield curve (30-year treasuries yielding less than 10-year notes) and we have a scenario eerily reminiscent of our last true bear market: the ’73-’74 crash. Japan’s 1980’s boom ended with a recession and protracted bear market that has lasted more than a decade. Given these potential dangers, why not move entirely to the sidelines? Because a much overdue correction in the major indexes would be healthy for the market, wringing out excesses and setting the stage for the next up move. Those budget surpluses, depending on how they’re spent, could add significant fuel to the fire (consider privatized Social Security accounts, for example). And we fully expect a return to value investing (buying established companies with real earnings) when the correction ends. That will create a huge migration out of the current hot stocks and hot funds, and require vigilance to keep our clients ahead of the crowd. In the meantime, here we sit, properly positioned between two very different outcomes.

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