Global equities rose again in October, with the MSCI World Index advancing 2.5% in US dollar terms. The US market lagged, with the S&P Index rising 1.5%, but Europe ex UK rose 4.3% while UK, Japan and emerging markets each rose approximately in line with the World Index.
There were no changes in either the constituents of the portfolio or the allocation to each of them in the quarter. The US dollar weakened against all currencies: by 1.3% against sterling, by 2.4% against the euro, by 3.8% against the yen and by 5.2% against the rand. Much of the gain in markets was therefore the result of currency strength rather than underlying market strength. Marvin & Palmer had another satisfactory month in October while Morgan Stanley also performed ahead of the MSCI Index. The performance of Merrill Lynch continued to be steady.
We had been prepared for a setback in equity markets in September/October, and the rise in the price of oil to a peak of over USD55 did hold the market back. However, the equity market proved resilient, and so we were not surprised to see it move ahead as soon as the oil price started to retreat. We always regarded the US presidential election as neutral for markets. Equity valuations remain attractive, both in absolute returns and relative to bonds and bond yields have remained below our expectations. Although the growth in earnings has slowed, there are signs that it has stabilised at satisfactory levels. Consequently, we are optimistic about the outlook.

Global equities continued to move higher in September, as a result of which the MSCI World index rose 1.9% in US Dollar terms, but was still down 0.9% in the quarter. Emerging markets were particularly strong, rising 5.8% in the month and 8.3% in the quarter, but Japan was correspondingly weak, falling 2.5% and 7.9% respectively. European markets rose 4.4% to close 0.4% higher in the quarter, and the UK rose 3.3% to end a net 3.1% up. The US was up 1.1% in September, but down 1.9% in the quarter.

There were no changes in either the constituents of the portfolio or the allocation to each of them in the quarter. The Rand rose 2.8% against the US Dollar in the month but fell 4.1% in the quarter, which reduced the monthly but inflated the quarterly Rand return of the fund. Marvin & Palmer had a strong September as a result of an improved investment climate for growth companies, and in particular, strong performances from industrials, materials and energy. However, a very difficult month in July meant that overall performance in the quarter was weak. The performance of Merrill Lynch was steady throughout the quarter, with relative performance gaining from underweight technology and overweight energy positions, but suffering from holdings in BSkyB and Fannie Mae. Morgan Stanley had a poor September, as a result of the fall in the share price of Merck and the weakness of consumer staples. This led to weak performance for the quarter, July and August having been flat relative to the MSCI Index.

We have been wary of a market setback in the seasonally weak period of September/October, possibly driven by higher oil prices, but the resilience of the equity market is impressive and we have turned more positive. Equity valuations are attractive, both in absolute returns and relative to bonds and would remain so even if US Treasury yields rose to 5%. We expect earnings growth to continue in 2005, albeit at a slower pace, and this will further improve valuations.

The second quarter was characterised by a continuing process of consolidation coming off a weaker base at the end of March. The MSCI Index was up by 1% in US Dollar terms. With the exception of Japan, which fell by 3.7% (TOPIX), major developed markets rose with Continental European markets rallying by 3% (MSCI Europe ex UK) versus a gain of 1.7% on the Standard and Poors 500 Index. Asian and emerging markets weakened sharply in May and have failed so far to bounce back convincingly along with the US and Europe in July. In large part, this resulted from the higher level of speculative interest and greater perceived sensitivity to the direction of US interest rates. From a sector perspective energy has dominated with a gain of 6.8% reflecting the surge in oil prices that is causing longer term oil price estimates to rise. Industrials (+4.4%) and the healthcare sector (+3.1%) also performed well. The weaker sectors were telecoms (-2.3%),
financials (-1.9%) and information technology (-0.0%). Once again value outpaced growth.

Consolidation remains the order of the day. Generally strong earnings growth is significantly lowering multiples on a forward looking basis. Equity markets have absorbed a spate of bad news comprising the onset of monetary tightening in the USA and elsewhere, higher oil prices a deteriorating situation in Iraq and concerns about a hard landing in China.

A further test of support is quite possible but assuming that global growth is now on a sufficiently self sustaining path the adjustment to a higher rate environment is manageable and as yet arguably undiscounted. From a style perspective the key issue is whether value's dominance has run its course. The fund has a broadly style neutral stance pending confirmation of this and it is noticeable that multiple compression between companies is now a feature of most developed markets.

After a weak April month, equity markets in the US and Europe rallied but those of Japan and the Far East failed to recoup their earlier losses by the end of the month of May. Over the month as a whole, in US Dollar terms, the US was up by 1.4% (S&P 500), Europe by 1.8% (MSCI Europe) Japan fell by 4.1% (Topix) and the Far East ex Japan fell by 2.3%. Overall the MSCI World was up by 1% in US Dollar terms but fell by 5.4% in Rand terms and that currency sharply reversed its recent sell off.

The bulls and the bears continue to slug it out and views remain highly polarised. The bear case is crudely that the 'reflation trade' has occurred now that key markets have retraced roughly 50% of their losses, that valuations are insufficiently attractive to support a sustained bull market and that earnings growth will fade once the monetary prop is removed. The bull case points to the globally synchronised and potentially self sustaining nature of the current global expansion. Strong productivity and earnings growth have continued to drive multiples down despite the significant advance in equity markets over the last twelve months. We tend to the latter view but anticipate further range trading before this debate will be capable of resolution.

Rising prospects of higher US interest rates, concerns about a slowdown of Chinese demand and rising oil prices combined to send markets lower. The US and European markets generally fared better than 'higher beta' markets such as Asia and emerging markets. Overall, the Standard and Poor's 500 fell by 1.6% and the MSCI Pan European Index was down by 0.7% whereas Japan's Topix, the MSCI Far East ex Japan and the MSCI Emerging Markets Indices declined by 5.2%, 5.8% and 8.2% respectively. From a sectoral perspective there was a marked shift in favour of more defensive sectors such as healthcare (+3.2%), Energy (+1.5%) and consumer staples (+0.4%). The principal losers were unsurprisingly sectors that had led the recovery of world markets since Autumn 2003 such as information technology (-6%) and materials (-5%). Overall the MSCI World Indexfell by 2% in US Dollar terms but rose by 7.8% in terms of a sharply weaker Rand.

The setback in world equity markets has continued into May characterised by a savage reduction in investor risk appetite. At the time of writing, key markets have become oversold and some technical rebound is likely. Underlying earnings dynamics remain strong and severe monetary retrenchment is unlikely. However, stabilisation in the bond markets is a likely precondition for a rebound in equities in the nearer term. The fund is well positioned for the present environment given its current defensive bias.

World equity markets strengthened in October as evidence of stronger economic growth rates continued to build in both the United States and elsewhere around the world. Earnings announcements have generally been coming in at higher than anticipated levels and top line revenue growth is evidently becoming more widespread. The S&P 500 Index advanced by 5.7% in US dollar terms, the NASDAQ Composite Index grew by a robust 8.1% and the Russell 2000 (small cap index) was ahead by 8.4%. Other markets also strengthened, Asia (ex Japan) particularly so with a gain of 8.5%. Japan was up by 4.1% (Topix) and European markets were collectively ahead by 6.7%. Overall the MSCI World Index gained 5.3% and the World Growth and Value style indices were closely aligned. The sectoral pattern remained consistent with the pattern of the last year with leadership being provided by the information technology (+8.9%), materials (+9.4%) and financials (+7.8%) sectors. The US dollar was weaker against the Yen (-1.6%) and Rand (-1.0%) and modestly stronger against the Euro.

The balance of probabilities suggests that growth and earnings surprises should continue to be positive as the recovery gains traction. Although monetary conditions are set to remain accommodative, we suspect that what started out as a liquidity driven cyclical bull market is likely to become increasingly earnings driven given that valuations are no longer definitively cheap in most of the larger markets.

However, the apparent synchronised global nature of the recovery in economic activity underpinned as it is with twin locomotives in the form of a resurgent US economy on the one hand, and the rapid emergence of China on the other, coupled with evidence of strong US productivity growth amounts to a constructive environment for equities.