September was another good month for international equity and bond markets; in part this was due to improving economic fundamentals. Sterling investors benefited from weakness in the pound, which lost 3.9% of its value against the euro and 1.9% against the dollar as investors fretted about the growing UK budget deficit and the spiralling cost of re-igniting the economy. Share prices are now generally up and the fund has been able to buy into high quality equities at what we believe to be attractive prices over the last few months, locking in a near 5% gross dividend yield without diluting the ability of the fund to grow over the medium term. The fund remains fully invested, and whilst we feel that equities will remain range bound in the lead up to the 3rd quarter reporting season, we expect investors to rotate into value and income-oriented shares as growth momentum falters.

Some of the momentum from earlier in the quarter was lost over the month of June. Opinions are very divided over the reason behind this modest correction in a number of markets. In some quarters it is felt it is too early to assume an immanent economic recovery is assured. The recent rally, largely driven by China stockpiling and indeed recording some early success with its stimulus packages may be inadequate to fully offset the deep seated problems in the west. The rebalancing of portfolios also appears to be largely complete for this stage of the economic and market cycle. Further evidence of the recovery is required before further tactical asset allocation can take place and therefore both economic and corporate data will be closely scrutinised over the summer months.
Unfortunately the World index has been held back by the modest 3% return form the US equity market and this does mean global investors will pay increasing attention to US economic data in order to gain a better understanding on how the economy is progressing and the role it will play as far as the rest of the world is concerned. Although there is a risk that markets may move sideways for a period, one should not underestimate the number of opportunities that are available.

Over the month of April a flood of money hit global equities and the returns especially relative to cash rates and inflation have been very strong. Against this backdrop although the main economies continue to shrink, the rate of decline has eased and combined with a significant number of companies reporting better than expected profits, there are now the ingredients of a new bull market in the making. Indeed taking the definition of a bull market being a 20% rally from the lows, there is perhaps a strong argument that the tide has now officially turned and it is only a matter of time before economic data confirms an economic recovery is underway.

With such a backdrop one would have expected commodity markets to have also performed well however there are a number of very mixed signals and clear examples of the market (and some of the stocks exposed to the asset class) ignoring the fundamentals. The price of crude has held up well but global inventories are running at multi-year highs and there appears to be a real physical lack of global storage. Surprisingly, this has not held back the price of crude possibly as investors look through this near term issue. Indeed some specialists believe it will take up to 18 months to clear the overhang although bull market conditions could quickly return once this occurs. Conversely, the price of pork bellies (and companies operating in this field) have plummeted on the news of the swine flu outbreak despite humans not being able to catch the virus from eating pork and the equity markets dismissing the situation as a none event. Such examples highlight the indiscriminate nature of the recent dash to invest cash without too much consideration of the supporting fundamentals and should act as warning to investors.

Whilst in general terms there are grounds to be positive there is no denying that it is China and America that are setting the pace whilst the outlook in many parts of world and in particular Europe remains unclear. A global synchronised recovery is therefore far from being assured. In addition the high levels of consumer and public debt in certain countries will also act as a barrier for a sharp economic rebound and there is every risk that just as a recovery gets underway, tax hikes or indeed higher savings rates will start to choke confidence. Overall we feel is it right to continue to drip feed funds into the equity markets, however it is important not to get carried away with recent dizzy returns. The developing world looks best placed for a sustainable recovery and those companies with global operations are best placed to benefit, however everything must have a price and if the move into this areas comes at the expensive of a major sell-off in domestic utilities for example, then investing against the trend and seeking value will likely result in a better overall performance. It will also cause considerably less anxiety when a period of profit taking occurs or when the markets decide to reappraise the time scale of the economic recovery.

Equity Market Review
Markets ended the year on a relatively good note after an appalling 2008. In dollar terms, global equities lost 20.9% of their value in 2008 despite double digit rallies in several markets in December. Once again, local currency returns were distorted by some momentous currency movements. In Europe, for example, markets gained a modest 0.75% in December but the swing of the euro against the dollar meant that such a movement translated into a gain of 10.6% in dollar terms.

The December rally was triggered by the realisation that interest rates would continue to be cut in all major markets in response to the growing threat of deflation. Ironically, deflation is generally considered to be negative for equity markets but there was a growing sense that the sell-off in October and November in particular had been overdone. Inter-bank rates are beginning to ease and low savings rates will eventually encourage savers to seek yield elsewhere. With the S&P 500, for example, yielding over 3% compared with a US discount rate of 0.5%, there is ample encouragement for investors to look to equities to provide income over bonds.

Elsewhere in the world, Asia and emerging markets generally enjoyed something of a rebound from the carnage of the previous few weeks and months, gaining 1.8% and 4.4% respectively in local currency terms. We do not, however, believe that such movements represent anything other than a relief rally at this point. It will take some time for the impact of lower interest rates to filter into the real economy and our inclination remains that of selling critically weakened companies (e.g. banks) into pockets of strength whilst building up positions in more robust businesses with strong cash flow, low debt and a progressive dividend policy on those darker days in the market.

From a currency perspective, we believe that sterling is probably in oversold territory and expect some of the recent movements to be reversed, particularly against the dollar, as 2009 progresses. Longer term, we remain nervous of the growing public sector borrowing requirements in most major markets (perhaps with the exception of Japan) but feel that President-elect Obama's spending plans will have a particularly detrimental impact on the US dollar over the medium term once the currency market's present obsession with a flight to safety has run its course.