When it was recently reported by Newsweek that Wesley Clark's Democratic candidacy grew merely from a few phone-related snubs by Bush advisor Karl Rove, it brought to mind other examples of ambiguity in today's political arena. Of course, Clark's embrace of the Democratic Party is peanuts compared to the post-2000 election conversion of Vermont Senator Jim Jeffords, or Michael Bloomberg, who ran as a Republican for Mayor of New York despite a long history as a Democrat. These might be isolated episodes, except for the more recent example of Republican Arnold Schwarzenneger, who before running for Governor spearheaded Prop 49, a costly expansion of state spending at a time when the state could least afford it. And then there is the uncomfortable fact that President Bush, an avowed fiscal conservative, seems to have an urge to spend at a rate comparable to FDR or LBJ. Note: Bush has not lifted the veto pen once, while federal outlays under Clinton, interestingly, grew at a remarkably slow pace. So despite General Clark's pedigree (highlighted by single-handedly threatening war with the Russians in Kosovo a decade after the Cold War had ended), we're not really shocked to see him join the Democratic nomination horse race - it's getting pretty difficult to tell the difference between the parties in any case!

In a similar vein, it's tough these days to distinguish between "growth" and "value" in the stock market. Like politics (where we presume a candidate's view on taxes or defense spending indicates party affiliation), investors often assume stocks fit into simple style categories, and these groupings determine investment success or failure. In fact, the substantial market moves since the mid-1990s have stressed how vitally important the choice between value and growth really has been: to have been a value investor in the late 1990s - or a growth investor in the ensuing three years - led to intense briticism and sleepless nights (thankfully, our long-term clients exercised patience and enjoyed solid investment returns over this rocky period). Now, the financial press and Wall Street repeat this parable over and over again, and thus the quest to identify the "correct" style - to figure out exactly where that bright line separating value from growth is drawn - consumes countless hours of effort.

For a variety of reasons, however, the boundary line between the value and growth investment styles is fairly ambiguous these days. First, the performance disparities evident in early 2000 reversed sharply in the following three years, so that even growth's huge performance advantage in 1998/99 was more than eliminated in 2000-2002 when the growth indices fell more than 20% annually. Through the first nine months of 2003, however, both styles are up nicely and within a few percentage points of one another, a fairly typical spread throughout most modern market history. Overall, many of the extreme high and low valuations we wrote about several years ago have been eliminated, replaced by a more normal distribution of valuations and opportunities.

Second, the emerging economic recovery creates some additional confusion: stated earnings growth for most companies is high right now, helped by the easy comparisons with last year's weak economy. While there are a number of definitional issues (whether to choose "operating", "reported" or "core"), 2003 earnings are expected to be substantially higher than those reported in 2002. These high rates of growth today, on average, make it a bit more difficult to determine the more important longer run trends in many businesses. Compounding this effect, the current low rate environment adds another positive factor to the equation: low interest and inflation rates mathematically justify higher valuations through discounted cash flow and dividend discount models used to calculate the fair value of a business. A review of historical market data show that inflation rates near or below 2% have easily supported average P/Es near 18-20x, markers that at first glance appear high when compared with the single-digit P/Es we took advantage of in the late 1990s in a number of basic, non-tech businesses.

But more importantly, the wide style swings of the past few years have created a real jumble: many of the former growth darlings are now at value prices, and vice-versa. Recently, we have found a number of attractive opportunities among the media, retail and healthcare sectors - areas we found much too expensive for our tastes in the late 1990s. While this represents a meaningful shift in our portfolios away from some of the mundane (yet cheap) holdings of several years ago, we view the move as clearly within the bounds of our value mandate. We always seek to own the best businesses available at the cheapest possible prices, and we recognize there is often a price/quality tradeoff. We also want to make sure there is an adequate cushion (discount to intrinsic value) in case we are wrong. From our perspective, the opportunity today for value investors is to own some of the strongest businesses, in particular those whose stock prices have stumbled to meaningful discounts to intrinsic value. Today's valuations are, in some cases, higher than those we could find some years ago, but the environment is quite different, and the bargains appear to be compelling over a multi-year investment horizon. It's worth noting that our average portfolio holding now produces higher operating margins and return on equity than the average stock, a significant quality upgrade since the late 1990s. Yet our average stock trades at a significant discount to the market and well below intrinsic value. We believe this combination offers good odds that our portfolios can generate attractive investment returns over the next few years.

Frankly, even we would admit that the whole discussion of the value/growth dichotomy has probably been taken a few steps too far. Over the past few years, the media scrutiny of this issue has been intense, to the point that the distinction has actually lost its meaning and potency. While some of our peers mechanically draw a horizontal line halfway through the list of stocks - separating value from growth based on statistics such as Price/Earnings or Price/Book - we think the task is more delicate. As the past few years have shown, issues of quality (management and industry environment to name just two) and risk play vital roles in determining business and investment success. A key part of our investment philosophy is that it's not just about price - it's about getting the best bargain given the quality and risk of the business, whether one's buying, say, a Ford or a Mercedes. Today, we see the discount we can find on a Mercedes as the better deal.

As for the market, we are encouraged to see the recovery from the lows of a year ago. The pessimism at that time was clearly overdone, as we argued, and those who ran from the equity market now realize the improving fundamental picture was masked by some macro issues (approaching war, terrorism, corporate governance scandals) that would soon fade. As we cautioned a few months ago, the market rarely follows a straight path, and we expect bumps in the investment road as the economy continues its own jagged recovery. Geopolitical risks, particularly in Iraq, add to the uncertainty, too. Predictions in this arena are treacherous; nonetheless, we suspect the fundamental picture is better than the headlines seem to indicate. If there is one thing we have come to rely on the past few years, it's that newspaper publishers know bad news sells well. We are exercising patience in our work, finding new purchase opportunities in a variety of industries, albeit at a slower pace than twelve months ago. Our long-term view remains quite optimistic.

Like the market and a number of global issues, the 2004 presidential election battle figures to grab a major share of the headlines. As we said earlier, it's important to look beneath the surface to determine the true nature of the candidates - party affiliations, like market styles, don't really tell the full story. The media loves to highlight huge apparent differences, but in the end, such categorization may be more distraction than help. It should be a typical frenzied contest: relentless fundraising, huge attack ad budgets, endless negotiations regarding acceptable debate formats and non-stop analysis from nearly every media outlet.

And so, we are disturbed by one inescapable fact: exactly one full year from now........there will still be weeks to go before the actual election!

Edward S. Loeb