The global outlook has strengthened, backed by aggressive stimulus measures in some countries. This improved financial market conditions, capital flows surged and industrial production rose due to inventory restocking. However, risk to a sustainable recovery remains. Most countries' exports are falling at double-digit rates, although the contraction has eased somewhat thanks to inventory restocking. Consumption remains weak due to negative wealth effects amid worsening labour conditions. The current market is characterised by low inflation, low interest rates, a strong rand, high gold price and a substantial recovery in equity markets. The portfolio is conservatively structured to cater for a possible pull back in the equity markets.

Global markets
Global markets are looking much better than in recent months! But, we are still in a recession. Globally, markets have stabilised. The free fall in the levels of economic indicators has diminished, but we are not quite out of the woods yet. The S&P 500 delivered an impressive 15.9% over the quarter. Returns on metals and oil also rebounded, with the latter up 50% for the three months to end June. Bond markets in general weakened due to the reversal of risk sentiment. Global economic free fall subsided and Asian regions, especially China, delivered positive returns driven by aggressive monetary and fiscal stimulus. Developed regions still delivered negative growth, but despite this, the decline in leading indicators has bottomed out - indicating a halt to the free fall. The US, Europe, Japan and the UK will deliver negative growth for the year but should demonstrate some positive growth in 2010.

Local market
Local consumers are struggling based on the recent statistics for retail sales and new car sales. The cuts in the repo rate by the SARB will take time to work through the system and industry-wide retrenchments are placing a damper on bank lending as demonstrated by the placid credit growth numbers. The South African PMI has turned from its lows, pointing to some deceleration in the negative growth trend. The absolute index level is still way below the magical 50 indicator level.

Portfolio positioning
Potential equity return growth is being held back my market uncertainty. Equity (SWIX 40) is expected to deliver 18% over the next 12 months with above average risk. Short-term interest rates are expected to maintain low levels over the next 12 months with a moderate probability of another 50 basis points reduction in the repo rate. The government borrowing requirement will keep the pressure on medium- to long-term (seven years and longer) interest rates making them unattractive relative to short-term assets. The equity portion of the portfolio is fully protected at current levels for the 2009 calendar year, having a moderate exposure. We are accumulating high quality credit in short end of the yield curve (one to four years).

Market performance
The local equity market delivered 8.6% (SWIX40 Index) while bonds had a fairly flat quarter. The one to three-year bucket of the BESA yield curve had a 1.4% return but the longer bucket's returns were negligible. Cash returned 2.2% for the quarter.

The equity market was down 4.5% driven by the financial and industrial sector while resources supported the market especially gold shares.

The bond market also had a negative quarter mainly driven by increased issuance, the ALBI total return index was down 5.1%.

Cash delivered 2.7% for the quarter.

The portfolio is structured to manage capital preservation over the calendar year. The initial draw down will be recovered over the term as the fixed interest building block generates income. However the expected total return of equities should enable the fund to reach the performance target over the next 12 months. The expected CPI + 5% target is around 12.8%, the expected portfolio total return is 14.2%. This is mainly driven by an expected asset class return in equities of 20%, cash delivering 8.4% and bonds 8.32%.

December marked the end of a tough year on a positive note. The All Share Index was up 1.52%, driven by Industrials which returned 5%, while Resources and Financials lost 0.2% and 1.2% respectively. Over the year the All Share Index lost 23.2%, driven by all three sectors. Resources lost 28.3%, Industrials 26.2% and Financials 26.2%.

The Bond market continued to rally with the All Bond Index up 7% during the month and 17% for the year. Cash returned 1% during the month and 12.4% for the year whilst listed Property was up 4.9% during the month and lost 4.5% over the year.

The Monetary Policy Committee noted improvements in the Inflation outlook in South Africa and decided to reduce the Repo by 50 basis points to 11.5%.

Please note that the Metropolitan Absolute Provider Fund was reclassified from the Domestic -Asset Allocation- Targeted Absolute and Real Return sector to the Domestic- Asset Allocation- Prudential Variable Equity Sector with effect from 1 January 2009. The history is retained.