September 2011 saw continued market volatility as investor sentiment gyrated wildly. The key risks that investors seemed fixated on were the Greek situation, a potential recession in America and slowdown in China. Market commentators were also increasingly concerned that the seasonal slow patch in the US financial markets might end up feeding its way into the real economy.

Global risk aversion hit emerging markets hard - previously resilient resource prices like copper finally capitulated (down 22% in dollars) as investors downgraded their long-term growth outlook. Investors fled back to the "safe haven" of US markets resulting in significant dollar strength against both the euro and emerging market currencies. The commodity focused emerging market currencies felt the brunt of the selloff with foreigners withdrawing money from both the SA equity and bond markets, pushing the rand from R7/$ to R8.20/$ by month end. The weaker rand acted as a stabiliser for the share prices of the large global companies on the JSE.

Investors vacillated between the belief that their worst fears were being realised, and the fear that they would miss out on undervalued shares appreciating sharply on the prospect of the abovementioned issues being resolved. The net result after much volatility was that the JSE All Share ended the month down 4%.

Notwithstanding the risks mentioned above (which have been known to the market for some time- besides the China slowdown), the real question is whether they have been sufficiently priced into the market. For example, the long-term commodity forecasts used in our valuations are still below current commodity prices. As a result, even after the significant declines in the commodity prices, we have not felt the need to adjust our longer term earnings and, therefore, continue to believe that the global diversified miners offer value.
The allocation to equities remained practically unchanged in September. Allocation to equities remains below the maximum allowed 40% and is unlikely to rise unless the fundamentals for the global economy improve dramatically or valuation becomes more compelling.

Developed market equities recovered sharply in April (Europe and Japan more so than USA) after the March selloff following the Japanese disaster, but fell in May and June on evidence of weaker economic activity and as Greek debt default fears intensified. Emerging markets were mostly negative as share markets declined on poor economic and commodity demand prospects; continued North African and Middle Eastern strife; and outflows from emerging market funds. Commodity prices abated on slower growth concerns and as speculative positions unwound, although gold rose while oil prices fell sharply as the IEA (International Energy Association) released stockpiles to (temporarily) offset Libyan supply loss. The euro initially rose strongly on higher Eurozone interest rates but weakened in recent times on US dollar demand as concerns about Greece intensified but recovered at quarter-end as Greece cleared legislative hurdles to avoid immediate bankruptcy.

The JSE tracked global emerging markets lower on increased risk aversion following growing Greek default concerns, but resource counters fell sharply on lower commodity prices. Bond yields fell as risk aversion globally resulted in lower yields, while foreign demand for SA bonds remains high. Interest rates were unchanged despite rising inflation and high commodity prices as economic activity continues to be below potential. The rand remained strong notwithstanding commodity price declines because of the strong gold price and continued net foreign inflows into the high-yielding domestic bond market. Economic activity surprised positively as a broader base consumer recovery takes hold and on early signs that fixed capital formation has possibly turned the corner.

The asset allocation reflects a higher risk environment compared to last quarter. The allocation to equities has been reduced, but is a shorter term tactical position. The larger cash balance can be used to buy quality companies when certainty returns.

The year started off fairly mildly with only Tunisia showing signs of political unrest. As the quarter progressed, so the unrestescalated leading to more than one leader stepping down. As the markets digested this and once again began grinding higher, it was once again hit from left field with the massive natural disasters in Japan. This, combined with the escalatingproblems in oil-rich Libya, caused substantial losses again. Although we built in fairly high oil prices into our forecasts, these negative surprises have definitely resulted in the oil prices moving higher than our base-case scenario. This has led us to a revisit of our short-to medium-term oil price forecast. This higher oil price has had obvious implications for the performance of Sasol, which ended the quarter up 13%.

Given the higher oil price, we are generally happy that our overweight position in retailers only marginally underperformed for the quarter after significant outperformance in the previous year.
Looking forward to the next quarter, global growth indicators are likely to soften somewhat on the back of the disaster in Japan and monetary tightening in China. We expect commodity prices to remain relatively firm, however, largely on the back of supply constraints. This should result in the rand remaining relatively firm and the recovery in consumer spending should continue. The equity component of the portfolio is well positioned to benefit from this scenario.

The portfolio has a maximum allocation to equity markets, both through quality South African equities as well as developed market equities through the international trust. The outlook for earnings remain positive which should provide some certaintyin producing returns in excess of CPI + 4% over a 3+ year horizon. The allocation to international assets is at the maximum allowed (25%).

Equity markets gained significantly during the quarter, encouraged by further US monetary easing and the extension of the Bush tax cuts, even though US jobs creation did not accelerate noticeably. The prospects for employment growth in 2011 are more positive, as growth is expected to remain strong, especially in fixed private investment and consumer related sectors. Interest rates were kept at nominal levels in developed markets, rose in selected developing economies, while the SA MPC decided on a further 0.5% reduction, given the lack of response from the demand side of the local economy from previous reductions, and a lack of job creation locally. The continuation of still low interest rates and further monetary easing has been a positive environment for growth assets, including commodities, and commodity prices in general rose substantially during the quarter. The rise in equity markets and commodity prices should also be seen in the context of possible higher inflation in the near future, and the threat to capital values from artificial weakening of currencies. Exposureto "real" assets like quality listed companies and commodities should play some part in preserving the capital of investors.

The portfolio's allocation to equity markets remain close to the maximum 40%allowed, despite recent gains in equity markets. The probability of achieving returns of inflation +3% is significantly higher in real assets -such as equity and listed property -compared to cash and government bonds. Quality companies remain cheap under most scenarios. We expect the companies we own to at least maintain earnings even if job creation is slower than expected. As a result, we remain positive about the long-term outlook for the quality companies in the portfolio.