Overview
June proved to be a tough month in local equity markets. A higher degree of volatility was evident although the market did well to contain its losses. Were it not for the ongoing demand for resource related stocks, particularly from global investors, the market would have ended significantly lower than the -0.95% posted by the All Share index.

Currency
The rand remained fairly steady against most currencies, helped by a weaker dollar. The outlook for the currency remains grim as the current account deficit looks unlikely to narrow in the near term.

Fixed Interest
Strong growth, sustained worries over the large current account deficit and upside surprises to inflation, dominated economic news locally over the part three months. Most concerning has been the unexpected breach by inflation of the 6% upper limit of the inflation target range. The SA Reserve Bank was left with no option but to raise interest rates in June after leaving rates unchanged at the preceding two meetings. Risks to interest rates remain firmly to the upside. The negative inflation data exposed the overvalued levels of longer dated bonds relative to cash during the past two months. The sharp sell off was justified and the market has now priced in a further interest rate hike of 50bps in August. We maintain that long-term cash yields offer better value in the shorter term.

Equity
Despite the solid rand, resource stocks were buoyed by strong investor demand and steady commodity prices. The pressure on interest rate sensitive stocks continued from May as inflation data clearly pointed to further interest rate tightening. The financial sector was hardest hit, ending the month 4.1% lower after a 4.3% correction in May. The mid and small cap indices posted declines of 4.0% and 1.3% respectively. Their respective annual returns of 54.0% and 71.3% remain spectacular. Although fundamentals for equities are less attractive than six months ago, we do not believe that it is significant enough to detract considerably from the relative valuation advantage of equities versus other asset classes. It is however reasonable to expect more muted returns for the balance of the year.

Property
The pressure on property stocks continued for most of June. Although the fundamentals have deteriorated for this sector due to the tightening stance of the SA Reserve Bank, we still believe a structural holding in property is essential within an economy which is experiencing an investment boom and growing in excess of 4.5% annually. In the long term, property will generate attractive capital growth while paying out a steady earnings stream.

After posting solid returns in January and February, the bond market came under pressure during March. This was due to a combination of cash outflows triggered by reinvest in the equity market after the short correction and some inflation concerns emerging.
During the month the oil price weakened significantly and maize prices continued to creep higher. Despite these factors, inflation appears to be well managed by the Reserve Bank. A further interest rate hike in April is a possibility as consumers are showing little sign of slowing its spending and borrowing spree. Property stocks continued to perform well. For the year to date, property stocks are now 15.7% higher. We are becoming more cautious on property stocks based on valuations.
Preference shares (depicted as equity exposure on the Asset Allocation chart) sold off sharply post the budget speech in February. This was due to the announcement that STC would be phased out and replaced with a tax on dividends. The impact of this move is still unclear, but with yields between 9.3%- 10.7%, preference shares are not unattractive.

The Select Manager Income Plus FoF returned 0.52% for March. The underlying managers have significantly reduced their modified duration of their funds as longer term bonds offer little value versus cash instruments at this stage.

The final quarter of 2006 was a profitable period for bond investors. The All Bond index returned 5.48% for the year, all of this return was achieved in the last quarter. 10-year bond yields rallied from 8.90% to 8.01% during the three months. The favourable outlook for the budget deficit of the next three years and its consequent impact on bond supply, continued to be a major supporting factor. However, this positive sentiment was further fuelled by better than expected CPI and PPI numbers for November. Expectations for further interest rate hikes were adjusted downwards. Oil prices are also continuing to tick down which is positive for the outlook of inflation. Bond yields are certainly not cheap, at best at fair value levels. A sell-off is however unlikely unless the inflation outlook deteriorates suddenly.
Property stocks returned 2.9% for December, ending the year 28.4% higher despite the significant price pressures experienced mid year. Again, property stocks are no longer cheap and caution is advisable.

The Select Manager Income Plus FoF returned 0.93% for the month and 7.09% for the year, matching the returns of the Stefi index for the period. This represents a solid return during a period where bonds lagged cash returns.