A number of factors have been driving the local equity market since the lows reached at the end of April, three of which are worth mentioning.

Firstly, the enormous re-rating which has taken place on foreign markets. This is unfortunately a mixed blessing, as we believe US markets in particular are over-priced and the rally has extended stretched valuations. The DOW has gained 32.5% since reaching a low of 7524 on 3 March 2003. The JSE reached its low on 28 April this year and has subsequently rallied at 34.3%. Ultimately, there is little escaping the positive and negative sentiment emanating from the market, which accounts for 55.3% of the MSCI World Free Index. Secondly, our market rallied because it was ridiculously cheap relative to other asset classes. Bond to equity yields had descended to levels past one standard deviation and many shares were trading on dividend yields exceeding 5%. Finally, economic conditions have suited a re-rating of our market, with interest rates declining 40% year to date, the discount rate has allowed for improved ratings for companies.

We have favoured domestic stocks to offshore or rand geared plays for the past two years, and continue to believe that this trend is likely to be sustained in the immediate future. In our opinion, the rand has, however, reached a point that increases the risk of a brisk re tracement to more appropriate levels. Considering that most of the dual listed companies are enjoying sound earnings growth in their primary listing currencies, a slightly weaker rand would mean that the existing pressure on rand earnings would begin to be alleviated. Should this not occur, we foresee increased pressure on dual listed companies’ share prices.

The Appleton Managed Flexible Fund enjoyed a very good month in October, having been increasingly exposed to equities in the preceding months. The fund delivered a return of 7.5% and came 4th in the sector.

Over the month, a number of changes were made to the portfolio, particularly with respect to reducing weightings in certain equities, which the fund manager's feel had appreciated to levels they were uncomfortable with. Positions reduced included Wilson Bayly Holmes-Ovcon, Afrox, Anglos, Sasol, Foschini and MTN. While most of these stocks remain on the fund manager's buy list, the lower exposure was implemented to diminish risk.

As far as performance going forward is concerned, the fund remains overweight equities relative to the funds benchmark, but have adopted a more defensive stance with respect to the type of companies held. Exposures to more defensive discount to net asset value plays have been accumulated in place of certain of the more cyclical stories. Bond exposure is currently non existant and cash will be increased if the equity markets continue their upward trend.

Over the past month, a number of changes have been undertaken to the Appleton Managed Flexible Fund. Considering September was a particularly weak month for equities, the time was utilised to increase exposure to certain stocks which the fund manager's believe to be undervalued, and to exit others that have enjoyed healthy gains of late.

For the period under review, the fund's relatively small exposure to Datatec was sold, prior to the release of the report indicating the pressures the company has been under and, thus, before the price collapse. The life insurer, Liberty, was also sold as it is the fund manager's belief that better value exists elsewhere in the market. Property exposure in the form of Sycom was halved due to the fund manager's concerns of overvaluation within the property asset class. While reducing exposure to the above mentioned counters, overall, equity exposure was lifted significantly during the month. This was achieved via the building of positions in Absa Bank, Remgro, Bidvest and Anglo American. It is the fund manager's contention that these counters currently offer significant upside. Banks have lagged the market's gains seen since April, and Remgro's net asset value discount has opened to above 25%, traditionally an excellent time to increase exposure. Bidvest has migrated to the lower end of its three and half year trading band, while Anglos should continue to leverage off the improving sentiment towards commodity counters. While the fund manager's appreciate that rand strength will hurt the commodity companies' earnings, the fund's extremely low exposure to cyclicals has been too aggressive in light of the better global backdrop. Hence the lifting of the funds Anglos stake to 6%.

The fund manager's believe that the latest changes should benefit the fund significantly in an environment where equities should outperform most other asset classes.

During the past month the local equity market powered ahead, with the action being dominated by cyclicals and in particular resources, quite contrary to most South African asset manager's views.

The large moves in August emanated from IT hardware, Steel and Other, Mining and Platinum, all delivering gains above or near the 20% level. These sectors, outside IT, have been stand-out poor performer's year-to-date which can be ascribed to the negative effects of the strong rand, and the fact that the global economy has been languishing. Local managers have wisely sought refuge in earnings certainty which has been found in companies who are locally focused and not the export orientated cyclical companies. The important question currently is the sustainability of the latest cyclical rally and whether more aggressive commodity exposure is warranted?

It is the fund manager's belief that justification has existed for a reasonable re-rating in commodity counters based on the improving global economic landscape. What they question is the magnitude of the rally and the speed at which it has occurred. As a result, the fund remains focused on buying into companies which are fundamentally undervalued and where their share prices are not sufficiently discounting the prospects of those companies. At this juncture it is difficult to place most local commodity counters in this category. The fund manager's will, however, build increased exposure on weakness.

An area of the local market which has become increasingly vulnerable is gilts. The fund manager's believe that local capital instruments are being too aggressively priced considering the extent to which the globe is enjoying a healthier economic backdrop, as well as the economic risks which a small open economy potentially faces. For this reason, the Appleton Flexible Fund has sold out of all gilt holdings. Similarly, the fund manager's continue to find value in equities and as such the fund is currently aggressively positioned within equities.

Those who have been watching the markets for years are well aware that when emotion drives share prices down to illogical levels and all that is in vogue is property funds, bond investments and guaranteed products, then value release is imminent. Such has been the case in 2003.

The JSE, whilst delivering positive earnings growth year-on-year, has been experiencing P/E contraction, in spite of sound fundamentals. Whilst earnings have definitely been contracting on resource counters, it has been the domestically focused companies, which have enjoyed booming profits. Retailers have been particularly impressive on the earnings front. This two-tiered market is precisely what the JSE has been undergoing since 1998. However, the difference since last year is that resources have become laggards. Obviously, the extended run on resource shares, which terminated early in 2002, can be ascribed in the latter half to rand weakness. Prior to that, resource shares ran because they were completely undervalued. This is what has happened to domestically orientated companies, where, for a while, the market adopted the approach that 'local is simply not lekker'.

The fund manager's remain convinced that poor earnings will continue to emanate from the offshore focused stocks, but with price movements already so bad, the fund manager's feel that these can be bought on weakness. Some of the local stocks have also been re-rated to more appropriate levels and value is no longer as obvious. As far as bonds are concerned, the fund manager's perceive little value in this asset class, preferring to find yield in high dividend paying shares. Property is also stretched on a valuation perspective. The fund manager's continue to believe that offshore markets are dangerously expensive, but the JSE has pockets of real value. The fund manager's approach is focused on areas of the local market where earnings momentum and dividend yields will sustain share prices should global uncertainties derail the market's current momentum.

The rand turned fund managers into currency traders again in June, with the market's flirtation with rand hedges which took place in May, being rather rapidly reversed over the past thirty days. The local currency enjoyed a powerful reversal of its May weakening pattern, strengthening almost 10%.

Naturally, the largest losses were seen across the rand hedges, with stand-out weakness seen in oil and gas, platinum and other mineral extractors, all falling 10% or more. In June, however, stocks that are sensitive to the local economy performed superbly, particularly after the inflation numbers were revised and the South African Reserve Bank slashed rates by 150bps. Although the All Share index fell 2.5% for the month, financials and industrials did well, rising 1.5% and 0.4% respectively. The local bond market also delivered the goods in June, rising 2.4%.

As far as the Appleton funds are concerned, the fund manager's were particularly cautious of bonds, concerned that global re-inflation will lead to a massive reflection point for this asset class. The funds remain underweight in bonds, choosing instead to pick up yield via high dividend paying equities. Appleton funds are also light on commodities, choosing rather to have overweight positions on the industrial and financial front. There is currently compelling value within the FINDI, but earnings momentum is negative for resource shares.

The fund manager's have certainly been advocating the virtues of local equity for ages, espousing statistics derived from decades of research, indicating just how cheap certain components of the JSE are.

Some relevant point made were that, firstly, the PE of the market had dropped to a point where a large decline in earnings, exceeding 15% was being discounted for the year ahead. This was inconsistent with analysts' predictions that anticipated flat to slightly positive earnings from the JSE. Secondly, the PE of the JSE has been at sub-10 levels this year. Historically, when the market reached such low levels, returns often exceeded 40% in the year following the PE fall. Finally, the fund manager's indicated that bonds were rather expensive relative to equities, with equity yields higher than bond yields and the equity dividend yield reaching 40% of the bond yields. This scenario was unsustainable and changed during May and June.

As far as asset class performance is concerned, bonds rallied almost 3%, as a result of the reconstitution of the inflation data - a pleasant surprise that caused capital markets to strengthen. The ALSI rallied 14% and cash returned 1%. The MSCI rose 6% in dollars and a whopping 18% in rands. The high beta areas of the local market were particularly explosive. Resources headed 20% higher, IT 35% and platinum 35%, which is exactly what the fund manager's expected in a bear market rally. Defensives such as drug and food retailers were actually down for the month.

The fund manager's consider local equities to be cheap, which should be elevated by forthcoming interest rate cuts. However, the fund manager's remain seriously concerned about certain developed offshore markets. They are dangerously expensive, and as such, the fund manager's strategy is one of caution and weighted towards local markets at the expense of developed bourses.

April was an interesting month, as global equity markets rallied, despite rapidly deteriorating economic data. The MSCI gained 0.5% in rands over the month. While the fund manager's have anticipated a rebound in G7 markets for a while, their consistent belief has been that this would merely be tactical - a relief rally within a bear market. The fund manager's continue to advocate this view.

Globally, economic data is poor. Buy-side managers are reducing their expectations for corporate earnings, with EPS expectations having shifted from 8% growth this year to 6%. The same applies to GDP forecasts, in January expectations for G7 growth were 2.4%, they are now 1.4%. Merrill Lynch point to the importance of the US needing to grow GDP by at least 3.5% per year to cut into the excess capacity that exists within the corporate sector. Unfortunately, predictions are for GDP growth of only 2% in 2003. Corporate earnings under such an environment are likely to remain under pressure.

Notwithstanding this bearish tone, South African equities are very cheap and deserve acquisition. What is important though is the visibility of earnings, with industrial and financials ranking higher in this regard. The fund manager's expect resources to deliver negative earnings this year, as against earnings in the mid teens for the Findi. Local equities are thus already priced for disappointment and exposure is justified. Foreign markets, on the other hand, are in many respects priced for perfection. For this reason, the funds equity exposure remains of a domestic nature, but asset allocation is conservative, with continued overweight positions in asset classes with low standard deviations of returns.

March saw equities fall further out of favour, with the JSE's negative 8% return even worse than the MSCI's decline of about 3% - a surprising result considering the valuation dilemma prevailing in developed bourses.

Once again, bonds and cash were comfort zones for South African investors, with both asset classes returning in excess of 1% in March. Particularly painful during March was the complete inability to escape the local equity malaise, as all thirteen constituents of the JSE All Share index delivered a negative return. During January and February, investors exposed to small caps or mid caps were offered some solace from the equity blues, but this was not the case in March.

While bonds, property and cash continue to provide investors with positive returns, the fund manager's perceive these asset classes as largely default investments. By this the fund manager's mean that investors have lost sight of valuation comparisons and are buying into property and bonds solely on the basis of the perceived risk within equities. The fund manager's concern with this approach is that currently the local bond market is pricing in CPIX of about 6%, and although they believe this to be feasible within a few months, the current inflation rate exceeds 11%. The local equity market on the other hand is priced for disaster, with an earnings yield of 10% and a dividend yield of 4%. In many instances, dividend yields of 8% can be found on the local market. The fund manager's believe this situation is unsustainable and consider equities to be cheap relative to bonds and property.

Although the fund did not deliver an absolute positive performance in February and was down 1.08% for the month, this was a great deal better than the All Share index's fall of 4.3%. The fund has remained aloof due to its exposure to bonds, cash and property, instead of merely equities. As far as the equity exposure is concerned, the fund has purposefully attempted to be very underweight the ALSI 40 counters. This was again a sound choice, as the small-cap and mid-cap indices declined by approximately 2.5% for the month, compared to an almost 5% decline for the top forty most tradeable shares on the South African market.

Bonds performed very well in February, delivering a return of 1.1%, the same return as cash. Obviously with an inverted yield curve, NCD rates are extremely high, hence the large cash returns.

Going forward, it is the fund manager's strong contention that equity prices are unsustainably low. Whilst the fund manager's remain negative on global developed equity markets, the same does not apply to the JSE. The fund manager's believe that many local share prices are currently only a function of sentiment and not economic reality. It is for this reason that the fund manager's remain avid long-term equity buyers.

The Managed Flexible Fund has retained a 70% weighting to equities, notwithstanding the current possibilities of a war in Iraq. The fund has also maintained the large weighting in inflation-linked bonds, which have continued to deliver absolute returns. With inflation and interest rates expected to decline in South Africa in 2003, this holding is likely to be reduced.

The fund manager's currently, don't intend reducing the equity holding, as in their opinion, the JSE is very cheap and more risk lies on the upside over twelve months than the downside. There are many companies listed on the local market that are trading below book value and are enjoying no goodwill on their existing businesses. The fund manager's believe this is unsustainable.

Whilst the JSE is cheap, the one primary risk over the following six months is that currency translation losses might be worse than the market expects for dual-listed stocks and other SA companies that have exported capital to foreign ventures. Bear in mind that with a weak dollar, most commodities are currently enjoying a dollar-denominated bull market. This is a massive paradigm shift, with the dollar having been strong since the early 1990's. It is thus not totally improbable, that the market might look through weak earnings from the larger SA companies, to a better period in the following financial year.

It is the fund manager's contention that short-term risk is rather tangible across global markets, but the JSE is priced extremely fairly and potential returns should more than compensate for the risk of retaining equity exposure.

There is currently no shortage of global concerns to upset even the most sound looking bourse. However, even taking potential risks into account, the current rating on our market together with likely potential returns, justifies increased equity exposure for the medium term. It is important to couch this prediction slightly, by providing for the passing of enough time. A gulf war, a terrorist attack, potential earnings disasters out of the US and many other exogenous factors stand a good chance of reaking havoc on the local indices in the short term.

This doesn't detract from the potential deeply embedded within the JSE. The JSE currently trades on a PE multiple of just short of 11, the second lowest level in seven years. The highest multiple reached since 1995 was about 20, and the mean has been 14.7 times. This implies that the JSE is the second cheapest it has been in seven years from a trailing earnings or historic perspective. This doesn't mean that the market is necessarily the cheapest from a forward or prospective earnings perspective, but it remains undeniably cheap. In Appleton's opinion, investors should expect earnings growth from the JSE of between 10% and 15% during the following 12 months. If the JSE enjoys even a slightly higher PE rating of 13 at any point this year, returns could be between 28% and 33%. Potential returns escalate if earnings surprise on the upside or if the PE heads higher than 13, or if both of these phenomena occur concurrently.

Bears worried about downside, can take comfort from the fact that if global markets fall in 2003, the JSE's expected earnings growth should offset a 10% fall in prices. No matter which way you look at it, from a probability perspective, potential rewards on the JSE in 2003 justify equity exposure.