Policy makers find themselves at a cross road: immediate implementation of stringent austerity measures to address the monetary overhang versus continued support to consumers and companies until the recovery is more entrenched. The major economic regions have adopted vastly different approaches. The US favours further support until there is sufficient evidence of a sustainable recovery. The UK and Germany have adopted a policy of economic austerity. The Chinese, having fuelled their economy with cheap credit over the past few quarters, are now becoming somewhat more cautious. The prospect of a substantially lower growth trajectory in the second half of the year seems increasingly likely. We have noted before that the recovery in the mining sector will be the anchor for the expected 4% GDP growth this year, the diamond industry's latest data indicated that it is starting to sparkle again with production for the first 5 months of 2010 totalling 580,000 carats, which is more than half of 2009 production. The Namibian Stock Exchange (NSX) Overall Index was down 10.6% over the quarter. The resources and financials stocks were down 15.4% and 9.7% respectively for the quarter, although Sanlam managed to have a positive 3 month return of 10.2%. The NSX Local Index was up 1.8% for the quarter. Both bonds and cash had positive returns for the quarter, with the IJG Bond Index being up 1.9% and the IJG Money Market Index (including NCD's) up 1.8%.

Market review
The improved global outlook has been somewhat less pronounced in the South African economy. Data releases over the quarter showed falling house prices, a manufacturing sector that is yet to benefit from any rise in global demand and very weak demand for credit by the private sector. The latter reflects a consumer under pressure from a high debt burden and general job market uncertainty. The sharp improvement in the current account is more a sign of a collapse in imports and lower dividend payments to offshore investors, than the effects of improved terms of trade and better export performance. Current estimates point to a marginal expansion in the third quarter, following a sharp contraction in the first half of 2009. The downward trend in inflation is likely to continue, but at a slower pace into 2010. Weak demand, the strong rand and the better near-term inflation outlook, saw the monetary policy committee cut interest rates by a further 0.5% to 7% in August. The All Bond Index returned 3% over the third quarter, while cash, as measured by the STeFI, gained 2%. On the Namibian front, the IJG Bond Index gained 3.9% for the quarter while the IJG Money Market Index rose 1.8% over the same period. Food and transport inflation continued their downward trend. Annual inflation came in at 7.1% for September, compared to 12% in September 2008.

Portfolio review
The Investec High Income Fund Namibia had a good quarter, outperforming its benchmark. We maintained some bond exposure and continued to selectively switch and add to credit exposure. The higher yield of the credit portion of the portfolio added to the overall performance and we also saw the first tentative signs of credit spread compression. We added duration to the portfolio through our bond positions. This contributed to the portfolio's outperformance, as bond yields fell modestly. Money market yields declined in line with the 50 basis point interest rate cut seen in the quarter. However, funding spreads remained wide, giving an attractive pick-up over three-month Jibar, also adding to outperformance.

Portfolio activity
In South Africa, three-month cash yields rallied 58 basis points to 7% as the South African Reserve Bank cut the repurchase rate to 7%. The one-year area managed a more modest 23 basis point move to 8.2%, as the yield curve steepened. In Namibia, three-month yields rallied by 30 basis points, but one-year yields actually ended the quarter slightly higher at 8%. The bond market was largely range bound, with the benchmark SA R157 rallying by 18 basis points over the quarter. We added duration to the portfolio, purchasing the 2014 maturity R206 on the government curve, avoiding the shorter-dated government bonds which still look expensive. In Namibia, government spreads to South Africa continued to narrow, helping that market to outperform. Cash duration remained largely unchanged, as we continued to favour the shorter end of the cash curve and the purchase of floating rate notes in both the South African and Namibian markets. Although we are somewhat constrained by limits, we continued to seek opportunities to increase the credit spread on the portfolio yield. We purchased some short-dated corporate bonds and invested in medium-dated credit-linked notes with attractive spreads over three-month Jibar.

Portfolio positioning
The final quarter of the year is going to be very important for the fixed-income markets. We have the medium-term budget policy statement (mini budget) at the end of October which gives the new SA minister of finance his first opportunity to adjust the official fiscal numbers. Much has changed since February and the market will be watching to see which direction the minister takes. We also have a change of guard at the South African Reserve Bank and the new governor will preside over her first monetary policy committee meeting in November. The communication from both these institutions will be closely watched for any change in policy. Inflation has slowly started to fall and we are now expecting CPI to remain in the low 6% range before breaking through the upper end of the band early next year. This should keep interest rates low for a while yet. Cash rates are now very low and bonds are offering a decent pick-up in yield. The 10-year bond is trading at 9%, giving a positive 'carry' of 2%. This comes with some risk in the form of increased issuance. Investors are thus torn between low cash rates and moderate inflation on the one hand and increased issuance on the other. We therefore expect bonds to remain range bound in the short term, before rallying next year as inflation breaks down into the band. The rand continues to participate in the risk trade, recovering from last year's extreme sell-off. If the local currency stays at around current levels for the next few quarters, it will have a positive impact on inflation and cause bond yields to rally further. There may then be a chance of further interest rate cuts. The rand remains one of the biggest risks - due to its extreme volatility it could drastically change the path of interest rates. This risk is compounded, given the Namibian dollar's peg to the rand. We are therefore keeping the portfolio conservatively positioned, but still looking to benefit from the higher bond yields and the attractive credit spreads on offer.