Market Review
The expected normalization in SA's real earnings base is currently underway, with some of our banks guiding earnings declines of 20% to 30%. The resources shares are also likely to see substantial declines in earnings and cash flows after the massive downward correction in commodity prices. Earnings in the retail and manufacturing sectors are also in decline and this will definitely feed through to our local industrial shares. However, we need to separate short-term economic impacts on profits and long term valuations. After all, two years of cash flows works are a small proportion of the net present value of a business. For this reason, the market is willing to "look through" many of the short-term challenges. In our first quarter commentary, we indicated that the market was implying at least a 21% decline in earnings and that much of the negative news was already "priced in" to the market. Since then, the All Share index has rerated by 8%, the INDI25 has risen 13.4%, the FINI15 is up 12.6% and the RESI20 2.6% is higher

What SIM did
Over the past year, we reduced our underweight in resources significantly based on our bottom-up assessment of where the value is in our investable universe. In particular, we added to Anglo. With the significant drop in the Anglo share price, we now believe it is trading below its intrinsic value. From a valuation perspective, it was trading at four times its net asset value in May 2008 (on peak of cycle commodity prices), while it is currently trading on a 1.5 times price to net asset value on more normalised commodity prices. We have started reducing our position in Anglogold, which has paid off handsomely over the last few months, and we're using the proceeds of this to finance better value opportunities. Within financials, we retain our overweight position in the banks. We expect bad debts to get worse in the short term. This is likely to result in banks' return on equity dropping sharply in the short term. We have already started to see some recovery in the bank share prices. Our overweight position in Old Mutual has also started to pay off. The share price has more than doubled since March 2009. Within industrials, we cut our shareholding in Telkom after the unbundling of Vodacom. We also reduced our position in Dimension Data. We used the proceeds of these sales to increase our shareholding in Barloworld, Liberty International, Liberty Holdings and Nampak. All four shares are trading well below their intrinsic value, with earnings below normalised levels.

SIM strategy
According to our measure of the intrinsic value of the various sectors on the JSE, which we determine through a bottom-up consolidation of our analysts' valuation of each share, resources are trading at about a 10% discount to our assessment of longer term intrinsic value compared with our May 2008 measure, which showed that the sector was trading at a 70% premium to fair value. This measure shows the INDI25 Index (the top 25 industrial shares) is trading at a 15% discount to its long-term intrinsic value, while the FINI15 Index (the top 15 financial shares) is trading at about a 20% discount.. We thus still see slightly more value in the financial and industrial shares relative to the resources, although the extent of the valuation difference has narrowed since May 2008. Given our assessment of the sectors based on our bottom up views, we remain overweight the FINDI and slightly underweight resources. We expect economic pressures to intensify in the short term. However, much of this is already reflected in many share prices and we would rather focus on the market's long-term value and exploit short-term emotional reactions.

Market Review
It has been another volatile quarter. Despite the fact that the All Share index increased by 10.3% in March (price only), the market fell 5.3% for the first quarter as a whole. From a sector perspective, the Resources index (Resi20) was up by 0.7%, the Financial (FINI15) index was down 9.7%, while the Industrial (INDI25) index was down 10.2% for the quarter. We need to prepare ourselves for further volatility in the markets in these uncertain times. We are, however, less concerned about the short-term movements and more focused on long-term intrinsic values. With this in mind, let's understand the current value of the market. The historic price to earnings (PE) ratio of the market is close to 8 times (as we calculate it). There is a high probability that, in the short term, earnings will "normalise" at lower levels than they are currently. Hence, the historic PE ratio is not necessarily a good indicator of current value as the "E" in the PE ratio is likely to drop and hence the PE ratio is higher than we think. According to our models, we expect a further 20% drop in earningsfrom current levels. It is likely that earnings might drop further, but we feel that this is now priced into the market. This doesn't mean that the market will not drop further, it simply means that according to our views a lot of negative news has already been discounted in share prices.

SIM strategy
We are first and foremost a fundamental, research-driven investment company - so we're always loath to generalise at the sector level. However, in our opinion the valuation differences between financials, industrials and resources have narrowed. At the beginning of last year, we had a strong view that the financial and industrial shares were much cheaper than resources. This has been the case fora while. However, with the large correction in many of the resource shares, that difference is now less obvious. We have reduced our underweight in resources. We see value in Anglo. The share price has dropped from R550 to R150 and we're in the process of moving to an overweight position relative to the benchmark. We also believe that Mondi is extremely cheap - although the fundamentals of the paper and packaging cycle will remain negative while we're in this global recession. We remain overweight AngloGold, which has done well for us recently. We are, however, seeing less value in the sector currently and hence we're using gold shares to finance other interesting opportunities. Within financials, we prefer the banks to the local life assurers (from a valuation perspective). We do, however, acknowledge the downside risks to earnings in the short term. We see value in Old Mutual though we have increased our exposure, but remain cautious due to the risks inherent in the US life business. For this reason, we will limit our overall exposure. Within industrials, we remain overweight the food retailers (Shoprite and Pick 'n Pay). Both are defensive businesses that are still offering value. We also see value in the diversified industrials (in particular Imperial and Bidvest). Imperial still faces many risks in the short term but, in line with our philosophy, we believe that earnings are well below normalised levels and the current valuation does not reflect a fair value for the business. In summary, it is easy to be sucked into the negativity of a global recession. It would be naïve to think that times will not be tough. We are likely to face many challenges and uncertainties in the short term. However, markets are driven by fear and greed. Just as they were driven by greed only a year ago, they're now being driven by fear - and therein lies our next big investment opportunity.

Market Review
Are we not glad that 2008 has past? What a year! The FTSE JSE All Share Index (total return) ("ALSI") fell 23.2% last year. Without playing down the significance of the correction that we've seen in SA, it's certainly not been as severe as some corrections in the past. Since the early seventies the worst fall was 57,4%, whilst the fall in 2008 only ranks as the seventh worst.

One also needs to put South Africa's 2008 performance in context relative to the rest of the world. The Global MSCI World Index dropped by 43.5% in 2008 in dollar terms (South Africa -45.4% in dollar terms). The best performing developed economy market was Japan (- 30.5%). The US was down 38.5%, while Europe was down 48.2%. The worst performing regions were global emerging markets (-53.5). So, in a global context, this has been a crash of huge proportions!

From a sector performance perspective, it has also been an extraordinary period. It was truly a tale of two halves. Between January and June 2008, the resources sector outperformed the FINDI by a staggering 57%. Between July and the end of December, the resource sector underperformed the FINDI by 43%!! For the year, it lagged the FINDI by 10%.

What SIM did
To round off the year and to summarise what we'd been saying for all of 2008, I refer you to our summary in the Q3 report: "Equity market returns need to moderate. We have spoken, at length, of the extent of the commodity cycle and the risk attached to a normalisation of returns. We spoke of the misconception that commodity shares suddenly seemed to be a "safe haven" or hedge against higher inflation and a weaker dollar - this would've been a first!

We believed that the FINDI shares offered greater relative value (versus resources) notwithstanding the risk of moderation in our local FINDI shares as well.

We also mentioned that we will continue the search for value; namely shares that are trading below their intrinsic. We spoke of the risk that, with developed economies moving into a recession, it is likely that emerging markets will also be under pressure - there is nowhere to hide in a bear market."

When markets collapse there are few places to hide. It was a year for being defensively positioned. Shares that did add value to the portfolio included Shoprite, Tiger Brands and Remgro.