The third quarter proved highly turbulent for global equity markets as problems surrounding the US sub-prime debt debacle spilled over into the credit markets, causing hedge fund investors to unwind significant positions.

The MSCI World Index posted a +1.95% return in US dollar terms.

The markets went through the first significant decline at the end of July and volatility peaked during August, when equities experienced some of the biggest one-day falls since 9/11.

However, interventions from central banks, including cash injections into the credit markets, prompted a recovery. Equities rallied on subsequent half percentage point cuts by the US Federal Reserve in its primary discount rate to 5.75% during August and in the benchmark lending rate to 4.75% in September. The financial sector led the recovery, as the S&P 500 Index enjoyed its largest rise on a single day since January 2003 and Europe's Dow Jones Stoxx 600 Index since May 2006.

At a regional level, all of the world's major regional markets posted positive gains, with the Pacific ex Japan (+12.1%) region leading the way. From a global sector perspective, household and personal products (+10.7%) and materials (+8.8%) were the best performers, the former helped by everhigher commodity prices.

Our view is that the overall impact of the problems surrounding the US subprime market and a tighter credit environment are likely to cause some slowdown in global growth, but should not result in a recession.

On the whole, global equity markets made good progress over the quarter, despite losing some ground in June. At the end of the period, the MSCI World Index posted a 6.2% return in pound sterling terms.

The Federal Reserve left interest rates on hold at 5.25%, citing inflation as the "predominant policy concern" for the world's largest economy. Economic data has been mixed. For instance, US retail sales figures were reported to have grown 1.4% in May, the highest increase in over a year, following a 0.1% decline in April. The US trade deficit also declined in April, falling 6.2% to USD58.5 billion, suggesting that a weaker dollar was improving the competitiveness of US exports.

Elsewhere, the European Central Bank opted to raise interest rates in June by a quarter percent to 4.0%. The Bank of England, meanwhile, increased interest rates by 25 basis points in May to 5.5% to mitigate inflationary pressures.

At a country level, in pound sterling terms, Portugal (18.3%) and Germany (16.7%) were the strongest performers. All other national indices finished the period in positive territory, with the exception of Japan, which fell 0.6%. From a global sector perspective, the majority of MSCI sector categories finished the month in positive territory. The strongest sectors were energy (15.7%), materials (13.7%) and capital goods (13.2%). On the other hand, the weakest performing sectors included real estate (-4.3%), household products (0.3%) and retailing (1.9%).

As the northern hemisphere approaches the quiet summer period, we continue to be optimistic on the outlook for equities, given a fundamental backdrop that remains broadly positive. While we can expect a period of consolidation in the near term, we believe that equity markets will continue to make progress this year.

REVIEW OF Q1 2007
Global equity markets had a positive first quarter, with the MSCI World Index posting a return of 2.2% in pound sterling terms. However, this number disguises a short but significant market correction, which bridged the months of February and March and saw world equity markets fall by around 6% in five days. The market's decline was triggered by sharp falls in the Chinese stock market amid rumours that the authorities there were about to pass legislation to limit the demand for stocks.

Investors found renewed confidence as they progressed through the quarter, with the market able to claw back some of its earlier losses. Of particular note was the US Federal Reserve's decision to leave interest rates unchanged at 5.25% in March, the sixth meeting in a row where it has left them unaltered.

Elsewhere, European interest rates rose again, as the European Central Bank hiked them by a further quarter percent in March to 3.75% in response to rising inflationary pressures. Meanwhile in the UK, the Bank of England opted to leave interest rates on hold at 5.25%.

At a regional level, all of the world's major regional markets posted positive gains (in pound sterling terms), with the Pacific ex Japan (5.8%) and Europe ex UK (3.7%) regions leading the way, followed by the UK (2.8%) and Japan (2.6%). The US market was the key laggard, with the MSCI USA Index gaining only 1.0%, as economic data disappointed.

Despite the market's recent setback, we remain optimistic regarding equities, as the fundamental backdrop appears broadly unchanged. While we can expect a period of consolidation in the near term, we believe that equity markets will continue to make progress during 2007.

Global equity markets ended the year on a positive note. During the fourth quarter, the MSCI World Index posted a gain of 8.5% in US dollar terms.

Global equity markets continued to take their lead from positive events in the US, where the Fed left interest rates on hold throughout the quarter. Interest rates have now been held at 5.25% for the fourth consecutive time, amid signs of a slowing economy. However, economic growth has slowed recently, partly reflecting the cooling housing market and a weaker manufacturing sector. However, while the rate of growth is expected to slow further, the economy should continue to expand at a modest pace. This has increased the likelihood of the Fed achieving a soft landing for the US economy and this has further helped to bolster global investor sentiment.

Meanwhile in the UK, the economy has continued to grow, prompting the Bank of England to raise interest rates in November to 5%, while the ongoing recovery in Europe has led the European Central Bank to also tighten its monetary policy. Japan continued to disappoint, given its somewhat fragile economic recovery.

In pound sterling terms all of the major global equity markets posted positive gains. The Pacific ex Japan (+12.1%) was by far the strongest performer, with Europe ex UK (+7.8%) and the US (+6.8%) registering more modest gains. Following closely behind were Japan (+6%) and the UK (+5.3%). US dollar-based returns, with the exception of Japan, were even greater given the marked decline in the dollar over the quarter as a whole.

From a sector perspective, all of the major MSCI World sectors closed the quarter in positive territory (in sterling terms). Leading the way were the materials (+12.7%), telecommunications services (+12.1%) and utilities (+10.7%) sectors, while healthcare (+0.6%) was the key laggard, given the poor performance of the pharmaceuticals, biotechnology and life sciences sub-sector - the only sub-sector to register a negative return over the quarter.

As we move into 2007 our outlook remains broadly unchanged. We expect continuing good performance from global equity markets given that the economic backdrop remains favourable for the asset class. While interest rates are expected to continue to rise elsewhere around the globe, we believe that interest rates have peaked in the US. Meanwhile, the supply and demand situation also remains positive for equities, as merger and acquisition activity remains rife and venture capitalists continue to hunt for well-priced assets.