Market Review
The year to date performance of the market has been dominated by the performance of Industrials (up 18.2%), followed by Financials (up 16.7%) with the Resources sector lagging with a negative total return of 3.6%. Overall, the All Share Index is up 8.7%, while the Shareholder Weighted All Share Index (SWIX) is up 11.8% so far this year. This trend continued into the third quarter with the SWIX Index delivering a whopping 14.3% return for the quarter. The sector trends continued with the markets returns being dominated by the Industrial sector (up 18.5%), while financials were up 15.2%. Resources ended the quarter up 7.1%. Financial and Resource shares have significantly lagged the performance of Industrials.

From a sub-sector perspective, exceptional performers were Media (30.7%), Automobiles (28.7%), Personal Goods (27.7%), Industrial Transport (25.9%), Mobile Telecoms (24.9%) and Forestry and General Retailers (both up 24.7%). Overall, we have been reasonably positioned, given our exposure to stocks like Mondi, Naspers, MTN and Vodacom, which performed relatively well. However, we do not hold much clothing retail exposure and we have sold out our shareholding in Shoprite and Imperial. The two worst-performing sectors during the quarter were Platinum (- 2.3%) and Gold (-1%). The only direct exposure we have to platinum is through our holding in Mvelephanda Resources, which is trading at a substantial discount to its underlying net asset value. The only direct exposure we have to Gold is through our holding in Gold Fields.

Meanwhile, the industrial sector's performance has been dominated by the strength of the rally in clothing and food retailers. We don't see any value in most of the retailers at these levels (although we do have exposure to Lewis, Steinhoff and Pick 'n Pay - all of which are trading below intrinsic value). Retailers such as Shoprite, Clicks and Massmart are best left for the priceinsensitive foreign investors who have already been loading up on SA retail shares. (The foreign shareholding of, for instance, Clicks has increased from 2% to 51%!) Finally, our banks and insurers have performed relatively well and, we believe, generally offer further upside to intrinsic value.

SIM strategy
Given the strength that we've seen in the Industrial sector year to date relative to the other sectors, we believe there is more value in the financial sector and increasing value in the small cap sector. In fact, for the first time in a long while, we also see better value emerging in Resources relative to Industrials at the aggregate level. However, we prefer not to look at valuations at an aggregate sector level but rather from a bottom-up, stock specific perspective. In this regard, we have been adding to Anglo, Billiton, Sasol, Steinhoff, Barloworld and Capital Shopping Centres. We have switched some of our holding in Firstrand into ABSAand Standard Bank. We have also sold out of Richemont and Imperial because both shares have done well for us and are now trading above their intrinsic values. We have started to reduce our holding in Mondi. Mondi has performed particularly well for us and has added tremendous value to the portfolio. We still believe there is some value to be unlocked here so we have retained a reasonable holding in the portfolio.

Outlook
At the aggregate level, the market is at our assessment of longterm fair value. However, the economy is showing signs of a sustained recovery. The interest rate cuts are likely to bring relief to a highly indebted consumer, but the stronger rand may put some pressure on our manufacturing sector. The persistent rand strength could lead to further unemployment.

Market Review
A sharp 8.2% decline in the JSE All Share Index during the quarter saw the ALSI price-to-earnings (PE) ratio drop from 18 times to 16 times. Assuming a 41% recovery in the market's earnings over the next year, which is the current consensus, the 12-month forward PE ratio has declined from 13.8 times to its current 11.3 times. By the end of the quarter, we calculated some 3% upside to the long-term fair intrinsic value of the ALSI based on our bottom-up, stock specific valuation. This assumes at least a 14% required return from South African equities when assessing the intrinsic value.

What SIM did
While more value has emerged as a result of the recent market correction, relative sector valuations have also converged and thus there is little to choose from between the broader sectors (i.e. resources, financials and industrials). However, we do see more value in the financial sector and increasing value in the small-cap sector.

In this regard, we have been adding to Sasol, ABSA, Mvelaphanda Resources, AGL and BTI. We have also added to some of the mid- and smaller-cap shares that are looking attractive including: Altron, Cipla and Iliad. We have continued to reduce our exposure to Imperial, while selling our entire holdings in Woolies, Amplats and Highveld Steel and Vanadium.

SIM strategy
The recent market correction has made us less anxious about the long-term return outlook for equities. The market is now offering some upside, albeit modest, to intrinsic value. The economy is showing signs of a recovery. The interest rate cuts are likely to bring relief to a highly indebted consumer, but consumer spending may be constrained by higher unemployment levels and factors such as higher electricity prices, which will negatively impact disposable income. The stronger rand and moderating commodity prices may put some pressure on our manufacturing sector. Notwithstanding this, we still believe the ALSI earnings will recover off the low base.

In summary, if we regarded the risk to capital as being high in late 2008 when the market was expensive, with few money making opportunities, and the risk to loss of capital very low in March 2009 when the market was cheap and there was enormous opportunity, we would see the current risk as moderate, with valuations fair, and thus the equity market as offering moderate opportunity.

Market Review

We believe domestic cyclical stocks have run ahead of improving fundamentals, and we are cautious about the level of optimism reflected in these share prices. We currently have no exposure to credit retailers and further outperformance from these stocks could impact negatively on our portfolio performance.

We remain cautious about the level of commodity prices and the potential short-term set back in construction company's order books. We are also not as enthusiastic about SA gold companies as others may be.

Our thinking has also been influenced by the uncertainty of the shape of the recovery and hence we attach a higher weighting to companies with predictable business models, which are, at their worst, currently trading at close to fair value. This would include our investments in SA Breweries, British American Tobacco, Pick 'n Pay, Advtech, Kagiso Media and Discovery.

SIM strategy

We have been well-positioned for this recovery. Some of the overweight positions that have added value to the portfolio over the last quarter are Mondi, Nedbank and Standard Bank. In addition, we have avoided a number of underperforming shares. For instance, we do not own Arcelor Mittal and Harmony, which were two of the worst performing shares in the FTSE JSE Top 40 index over the past quarter.

A number of shares we have owned for some time now and that have added significant value to the portfolio include Imperial and Woolworths. We have begun reducing our exposure to these shares as they have approached our assessment of intrinsic value and, in certain instances, have now exceeded our best-case measure of fair value.

Outlook

The current market consensus earnings growth expectations for calendar year 2010 are being revised upwards and are approaching 30%. This is off the low base set by last year's 29% decline in All Share earnings. With the economic recovery in sight, these earnings expectations are not unreasonable. We are less concerned about this and more concerned that at current valuation levels of the market there is little scope for a disappointment in the recovery. The market is already discounting the recovery and therefore investors should moderate their expectations of future real returns.

Risks and opportunities

One of the risks we face in the medium term is that inflation could surprise on the upside (although this is not our base case view). This could be partly due to the secondary effects of electricity tariff increases and, in the long-term, a shift in SA's tariff structure induced by a slight change in government policy. Other risks include higher unemployment levels and a potentially weaker rand given our view that the currency is unsustainably strong.

However, we do have a number of opportunities in 2010, not least the positive impact that the Soccer World Cup is likely to have on the economy. In addition, the 550 bps in interest rate cuts are likely to start having a positive impact on the consumer, as well as corporate SA in general.

As we indicated in our last quarterly report, although we expect moderate returns from equities off their current "fair value" base, equities are still likely to generate real returns.

Market Review
At the beginning of last year, few investment managers would have forecast the strong returns we experienced from equities in 2009. This has certainly felt like the best of times, especially from the low base in March 2009, when the JSE FTSE All Share Index was on a price-to-earnings (PE) ratio of 8 times at its lowest point in March 2009 after falling about 38% from peak to trough. This was well below the long-term average of 11.7 times since 1961 and 14.6 times since the economy opened up to the rest of the world post-1994. This strong rally took place while we were experiencing the worst of times in terms of earnings, with a 29% 12-month decline the worst on record. It seems, therefore, that we have completed the normalisation in the earnings process. What remains uncertain, however, is the speed and magnitude of the recovery in 2010 and beyond. Looking back at 2009, we probably had two years worth of equity returns in one year and the equity markets are probably now fairly valued. Looking forward, the equity returns in the earnings recovery phase have traditionally been much more muted than during the "hope phase".

SIM strategy We were well positioned for the equity market recovery in 2009. Not only were we generally overweight equities but our stock picking was good and thus added value to our fund. Some of the positions that added value in particular in the portfolio during 2009 were Anglo, Naspers, Old Mutual, Imperial, Shoprite, SABMiller, Afgri and Spur. More recently we began to reduce our exposure to some of these stocks as a few of them are now trading close to, or above, our assessment of their fair intrinsic value. For instance, we sold out of our position in Shoprite and started to reduce our exposure to both Imperial (although we still see some upside) and Naspers. We now see compelling value in British American Tobacco and have started increasing our holding of the share. In addition, after MTN's recent underperformance, we have started to increase our exposure to the company.

Outlook
The current consensus earnings growth for 2010 is 24%. Even when you exclude the high earnings growth expected from gold, platinum and industrial metals, earnings growth from industrials and financials is expected to be around 23%. There have been only six periods in the past 47 years when annual earnings growth has exceeded 20% on a rolling 12 month basis. Our expectation is for a much more muted recovery in earnings growth over the next two years, with the market close to fair value and prices likely to remain range bound until earnings catch up. However, on a long term basis equities are still our preferred asset class because returns on cash remain low. Since 1928, annualised returns on the JSE have averaged 13.8% compared with 6.1% inflation. Over the same period, cash delivered 6.9% and bonds 7.8%.