Global equity markets proved to be remarkably resilient throughout the quarter, shrugging off some of the world's worst terrorist attacks and natural disasters. Investors continued to direct funds towards areas perceived to offer better growth prospects, such as the Asian economies. As a result, emerging markets continued to outperform developed markets. The Morgan Stanley Emerging Markets Free Index outperformed the general global index by some 10% over the quarter. Regional allocation is likely to remain important, as equity markets have provided quarterly performances (in rand) ranging from over 20% for some Asian markets to -2% for the US. Among developed markets Japan performed well, with investors gaining courage from a favourable election earlier in September.

As we enter the new quarter, reality seems to be setting in. Global equity markets have corrected somewhat in the early weeks of the quarter as investors tempered their rather enthusiastic growth forecasts in the face of further rate hikes, particularly in the US. Again, the Asian markets have outperformed during this correction.

While valuations in global equity markets are generally reasonable, a potential sell-off in global bonds remains a risk, and a further pull-back in equity prices may represent the opportunity to buy in at lower prices.

Global equity markets remained flat for the quarter, but rand weakness against the dollar resulted in improved fund performance in rand terms. Oil prices hit all-time highs, which fuelled fears of inflationary pressure. There are concerns that oil producers may strain to meet demand, which will send the price up even further. The Fed again hiked rates by 25bps, and rates above 4% to curb possible inflationary pressure do not seem inconceivable. Corporate US is in good shape and the US trade deficit widened less than expected in April as record imports signalled healthy consumer demand and unprecedented exports provided good news on manufacturing. Strength in exports from manufacturers led some economists to raise growth estimates and the dollar climbed to a nine-month high against the euro. Positive sentiment still exists on US equities; however, the risks continue to rise. Three key factors continue to suppress exuberant optimism in the US, namely interest rates, the oil price and rising input costs.

At a recent meeting of G8 finance ministers US, Japanese and IMF officials again urged China to end its decade-old currency link to the dollar. Asian currencies revaluing would eventually be great news for the West. It should trim Asia's competitiveness and it should increase the buying power of the Asian consumer - all of which would bring joy to Western exporters and improvement to the US current account deficit. The potential revaluation of Asian currencies would result in reduced Asian competitiveness and would impact different sectors in different ways.

The fund has a relatively large holding in Google shares. These shares have more than trebled in value since the company's initial public offering in mid-August. In April, Google posted a first-quarter profit that was almost six times higher than a year earlier. Google recently ousted eBay as the Internet's most valuable name with a market valuation of more than US$87bn and is also the world's highest-valued media company, overtaking giants like Disney and Newscorp.

A distinct move to increased risk aversion has emerged in US and global equity markets. This risk aversion has been driven by two key factors, an oil price that is resiliently high and an increase in hawkish sentiment emanating from the Fed, that inflation is rising and may jeopardize the "measured" rate increases. This would force the Fed to tighten at a more aggressive rate. While emerging markets have been the hardest hit, there has been a switch from equities to more defensive asset classes. The US earnings numbers beat consensus forecasts for the 7th consecutive quarter. However, earnings growth momentum in the US is showing clear signs of a slowdown from peak levels in July last year.

The Euro area remains unattractive from an equity perspective. It is likely that the Euro area will underperform other regions from a growth perspective in 2005 and will only be able to eke out around 2% growth for 2005. There are signs that improvements are under way in Europe, and the shift from exports to domestic consumption is encouraging, as it signals an improvement in domestic demand. We do not expect the ECB to be as aggressive as the Fed during the next 12 months. In recent months Europe has significantly underperformed the US equity market largely due to the growth differentials between the two economies. Unlike the US, Europe has not been a beneficiary of strong domestic demand, although there are signs of a slow improvement. Therefore, European valuations are becoming increasingly compelling. Headwinds of restrictive monetary policy and high oil prices will continue to suppress any major turnaround in this market.

The Japanese stock market has withstood the pressures of the slide back into technical recession in the past quarter. Whilst we remain concerned that the Japanese economy is still stalling, the equity market appears to be supported by strong corporate profits that have been sustained despite the poor economic backdrop. Japanese corporates continue to move from the restructuring phase into the growth phase, and corporate spending continues to respond to high profits. Recent improvement in these markets combined with improving employment has contributed to improved domestic demand. The derating of the Japanese equity market continues, although the pace of derating has slowed. The Nikkei remains a highly cyclical market focused predominantly on auto manufacturers, industrials and manufacturing industries.

Global equity markets, measured by the MSCI World Index, ended 2004 positively and delivered a return in excess of 12% in US dollar terms. The South African rand appreciated by 14% from R6.60 to R5.66 against the US$ and for the third year in a row diluted rand returns of international investments.

Most major countries and regions delivered positive returns over the year, with Korea and Brazil being the star performers with returns in excess of 25%. Europe performed well, mostly on the back of euro strength, and the FTSE, Dax (Germany) and CAC (France) generated returns in excess of 15%. Although still positive, the Japanese and US markets were the relative losers with returns of between 8% and 13%. Even with a strong fourth quarter, the technology-driven Nasdaq was a laggard in global terms.

Industries that performed really well included oil and gas (due to the record-breaking oil price), steel and hotels. Semiconductor stocks declined by over 15% and pharmaceuticals had a difficult year, driven lower by large stocks such as Pfizer and Merck.

Two big stories on global financial markets were the dollar slide and oil prices. The dollar again lost against the euro and the yen mainly due to deficit concerns but also due to speculation that foreign demand for US assets is waning. Crude oil prices surged in 2004 to levels above $48 a barrel. In spite of these high prices, OPEC, which controls more than a third of world oil production, decided to cut output by more than 1 million barrels on 1 January 2005.

One of the major concerns regarding the US is the budget and trade deficit, which affect the demand for US assets. US imports continue to grow (demand for oil and consumer goods from Asia) and exports are falling, widening the trade deficit, which ended November on a record high of $60bn. Retail sales are holding up, driven by low interest rates and a more stable economic outlook. Company earnings growth in the US is expected to slow to around 10%-12% in 2005, down from the 18%-20% level achieved in 2004. Euro land remains in a difficult position. The strong euro and the 30% rise in oil prices have left their mark on the economy and unemployment is running at a five-year high.

Hong Kong ended the year strongly, driven by optimism that the property market and the retail sector will continue to perform well. Property stocks accelerated by 23% in 2004. Taiwan authorities raised interest rates towards the end of the year on the back of continued good growth expectations. The Japanese economy continues to recover at a moderate pace, but a weak dollar resulted in slower than expected export growth. Goods news emerged when machinery orders from industries such as insurance, telecoms and banks rose the fastest in nearly four years in November. Corporate investment are picking up and, according to Tankan, large manufacturers plan to increase capital spending by 23% in the year ending March 2005. Capital spending accounts for more than 50% of Japan's economic growth.