Market review
The second quarter started on a negative note, with Spain struggling to place its bonds as concerns over its relatively high primary government budget balance of 4% to gross domestic product (GDP) resurfaced. Politically, there continues to be a swing to the left, with new governments in France and the Netherlands further advancing the cause of growth over austerity in Europe. The developed world economic growth rate appears to have stalled after two years, with credit growth dipping and unemployment remaining stubbornly high. The anxiety regarding a possible Greek exit in June and the potential spill over effects into Spain and Portugal pushed US borrowing costs to March 1946 levels of about 1.6% and to all-time lows for Germany and the UK. Data from China continues to weaken, forcing the authorities to continue slashing the reserve requirement for banks. Policy makers are anxious to maintain trend economic growth of 7.5% to 8% a year. China retail sales weakened from a run rate of over 20% a year to 15%. Not even the $100bn Facebook IPO helped lift market sentiment. Brent oil fell back 26% putting it officially in bear market territory. In SA, the mining sector is recovering, while manufacturing remains under pressure. Our fate is linked to the fate of the global economy, especially Europe, which is still a major trading partner. Contrast this to Australia, where terms of trade are at 150 year highs and mining capital expenditure has been booming; providing a boost to the Australian dollar. SA retail sales momentum on a quarter-on-quarter basis weakened in the first quarter of the year, with the terms of trade deteriorating as commodity prices have pulled back. The one statistic bucking the trend remains new vehicle sales, which are growing at close to 16% a year, driven by strong rental car fleet replacement demand, strong instalment credit sales of 14% a year and possible pre-emptive buying by consumers ahead of car price increases induced by the weaker rand. We still forecast economic growth for the full year of between 2.5% to 3%. A bit of calm was restored to global markets when Greece elected a new pro-Europe government and Spain finally received a €100bn bailout for its bank rescue fund, which is equivalent to 10% of GDP. At the end of June, the European Union (EU) summit led to an agreement to support Spanish and Italian banks further. But bankers remained out of favour, with JP Morgan recording large credit derivatives losses and Barclays being fined for manipulating the Libor rate.

Performance
The JSE RAFI 40 Index delivered a total return of -0.42 % during the second quarter - below the JSE ALL Share Index return of 1%. Contributors to this underperformance were Barloworld, Telkom and Impala. Sanlam and FirstRand managed to negate some of this underperformance. There were no constituent changes during the June Index review as this index only gets reviewed once a year in March.

Valuations
The JSE ALSI Index is trading on a forward price-to-earnings (PE) ratio of close to 11x, in line with its long-term average level. (PE) ratio of close to 11x, in line with its long-term average level. We expect earnings growth of 16%, driven by resilient Findi earnings growth, this year. On a sectorial basis, resources are on a forward PE of 8x. From a long-term perspective, we believe the stock market is now trading slightly below fair intrinsic value. The performance of indices on the JSE has diverged considerably between Findi and Resources stocks. With the indices diverging again during the quarter, we see considerable value in blue chip resource stocks like Anglo American, which is trading at a forward PE of under 7x. Contrast this to Massmart, which is trading on an historic PE of 26x and a one-year forward PE of 20x!

Market Review
The quarter started with S&P downgrading nine European sovereigns. However, January saw a rally inspired by the anticipation that central banks would have to inject more liquidity into financial markets. Global equities had their best January since 1994 and the US market its best start since 1987. With riskon sentiment prevailing again, foreign investors flocked back to the JSE. The Chinese economy is clearly slowing and we expect a soft landing this year. In SA, it is evident that the consumer has been on a spending spree, with retail sales over the Christmas period jumping from 7.2% to 8.7% a year in real terms (but double digits in nominal terms). However, what is evident is that consumer inflation will start eroding the real income growth enjoyed by consumers over the past few years. In addition, we remain concerned that the rapid pace of unsecured lending has found its way into consumption.

Performance
From a performance point of view, the JSE Rafi 40 Index delivered a good return of 6.6 % during the first quarter of 2012, which compared favourably with the returns notched up by most of the market capitalisation indices - the All Share Index delivered a return of 6%. Shares that contributed to this performance were the overweight positions in Barloworld, Old Mutual, Imperial and Standard Bank. Some of the outperformance could be attributed to the Rafi 40 Index's underweight exposure to gold shares. . Several changes to the Index happened during the March rebalancing. New entrants were British American Tobacco, Kumba, Harmony Gold and Murray and Roberts, while Mondi, Massmart, Investec, Lonmin, Impact, Reinet and RMB Holdings were removed from the index.

Valuations: Trading at Fair Value
The JSE ALSI Index is trading on a forward PE of close to 11x, in line with its long-term average level. We expect earnings growth of slightly below 20%, driven by resilient Findi earnings growth, this year. On a sectorial basis, resources are on a forward PE of 8x. From a long-term perspective, we believe the stock market is now trading close to its fair intrinsic value. The performance of the Findi and Resource indices on the JSE has diverged considerably. With the JSE All Share delivering a total return of 6% in the quarter, it is now much more difficult to see much value in local equities.

With the indices on such different trajectories, we are now seeing some pockets of value emerging. But some sectors are becoming overheated. We see over 20% upside in blue chip resource stocks like Anglo American and BHP Billiton. In the case of Anglo American, the rump (i.e. Anglos excluding listed subsidiaries Angloplats and Kumba) trades at a low single-digit price-toearnings (PE) ratio. On the other hand, we see a number of local industrial stocks, such as Massmart, Shoprite and Tiger Brands, being increasingly owned by foreign investors and trading at very extended valuations, with PE multiples in the 15 times to 20 times range.

Risks and Opportunities
Investors seemed to have been spooked by the prospect of a dramatic slowdown in Chinese economic growth, while the economic prospects for Europe remain uncertain.