The third quarter of 2011 represented one of the most difficult quarters in financial markets since the collapse of Lehman Brothers marked the emotional low point of the banking crisis in 2008. In some ways, these latest falls were worse, coming as they did at a time when markets were starting to show modest signs of recovery. In the event, the massive structural issues facing Greece and the lack of firm leadership by the European authorities precipitated a flight to safety to US and UK government bonds, despite the low interest yields on offer and the prospect of guaranteed negative real returns.

Whilst low yielding sovereign debt markets in the US and UK appear to be overvalued, corporate bond markets have been negatively affected by the recent market turbulence. Excluding financial borrowers whose debt has been weak for more fundamental reasons, a major cause of corporate bond price weakness has been illiquidity accompanied by a relative lack of transparency in pricing thinly traded bond issues. These are difficult times for bond investors and we remain underweight, preferring government index linked issues for safety and very short dated corporate issues for yield although neither represents especially good value, in our view.

The majority of equities in our International Funds have exceptionally strong balance sheets and remain long term safe havens because of the defensive nature of their earnings, their liquidity and their high dividend yield. They, however, have been subject to high levels of volatility. Liquidity is generally considered to be a strong attribute of any security but in times of crisis it can be a hindrance as hedge funds and large programme traders sell their most liquid assets to meet margin calls, irrespective of the fundamentals. Certain sectors have been avoided. For example, we continue to avoid bank stocks as over-regulation and, in many instances government ownership, will subdue earnings for some years to come.

Whilst Europe's problems have been reflected in the dire falls in their equity markets over the quarter, America at least is showing a little more resilience. The latest US GDP numbers show a modest improvement in this economy although the fragility of this recovery will not be helped by the recent surge in the Dollar. Whether committing fresh capital to equity markets or reinvesting income, it is important to remember that the most attractive buying opportunities often occur in an asset class when the majority of investors are fearful, become forced sellers or have just given up. Recent acquisitions by a number of major quoted companies show that they see excellent value in the stockmarket. United Technologies, for example, paid a near 40% premium to the market price to acquire aircraft components manufacturer Goodrich whilst Hewlett Packard paid a similar premium for the UK software company Autonomy. A surprising number of deals of this nature are currently taking place whilst the number of new issues has all but dried up. For investors who are prepared to be patient, equity market falls of this magnitude represent an opportunity rather than a threat and we are selectively adding to holdings on those on weaker days of the market.

Market sentiment in the second quarter of 2011 was dominated by Europe and, in particular, the threat posed by a Greek default. After weeks of procrastinating, the European Union and the International Monetary Fund eventually agreed to bail out Greece after the Greek parliament had agreed to implement an austerity package designed to reduce their crippling level of debt.

Ironically, Greece's problems saw the Euro rally during the quarter, by 2.2% against sterling and by 2.4% against the Dollar perhaps as a result of the expectation that Greece was likely to be expelled from the eurozone and that the Euro would be much stronger as a consequence. A more likely view, is the possibility of a Euro style Brady bond package of the type used to bail out a number of emerging markets in the late 1980s. (Brady bonds were issued as special bonds backed by the US Treasury and allowed the countries concerned to restructure their finances without defaulting). A Euro version would throw a lifeline to many of the banks currently exposed to the Greek crisis and also provide a solution to the problems faced by other fragile Eurozone members such as Ireland and Portugal. It would, however, require decisive action by the EU and the IMF.

Elsewhere, equity market returns have been driven as much by currency movements as by genuinely improving fundamentals. In sterling and dollar terms, global equities gained just 0.4% over the quarter after a promising start derailed by the Euro crisis.

Bond investors fared better. Sterling bonds rallied by 2.6% and Dollar bonds by 2.5% as investors decided that interest rates were likely to remain lower for longer. Certainly, there was little rush to buy equities although with inflation still significantly above trend, government bond (and cash) investors appear to be resigned to accepting negative real returns. Equity valuations in general are fair, but the dividend yields of securities in the Marriott portfolios are attractive.

In our view, higher yielding equities in carefully selected blue chip names represent the most sensible way to combat inflation at present. We expect this theme to gather momentum over the rest of the year, as investors focus their equity selections on well known names in their domestic markets, particularly those paying a good dividend yield. We expect interest rates to remain lower in the UK, Europe and the US for far longer than is generally being recognised. Central banks may use any softening in inflation data as an excuse for this strategy but the reality is that benign neglect of their domestic currencies and any subsequent devaluation is a relatively easy and painless way of improving current account deficits, helping exports and therefore lowering unemployment, something the Obama administration will be desperate to achieve before the 2012 election campaign gets underway. International equities should benefit in this environment and here, The Marriott International Growth Fund is especially well positioned.

Markets have endured a mixed first quarter to date with geopolitical events overshadowing a generally positive corporate outlook. The US, in particular, has continued to forge ahead, partly thanks to the second round of quantitative easing which has injected nearly $600bn into the US economy. Consumer confidence figures have rebounded, unemployment is falling, albeit slowly, and corporate earnings are supporting higher dividend payouts. The real uncertainties are being generated by massive geopolitical concerns. The moves towards democracy in Tunisia and Egypt have been overshadowed by the events in Libya where the country's president remains in office despite calls for abdication from the UN. With the Libyan crisis occurring at the same time as the ongoing power play in the Ivory Coast, the world is crying out for some strong leadership. All of this has, of course, served to drive energy prices higher. Whilst OPEC can flood the market in the short term, longer term a high oil price will undermine the fragile global economic recovery at a time when inflation is already creeping higher and interest rates can go no lower. The unfolding tragedy in Japan underlines the continued globalisation of capital markets and the threat of apparently unrelated events correlating to put pressure back on global stock markets. We commented earlier in the year that we expected market volatility to continue unabated in 2011. Until recently, we had expected the driver of such volatility to come from Europe where we still have concerns over how the peripheral nations of the Euro zone will adapt to the long period of economic adjustment which they will face as interest rates move higher. All of this means that we are being vigilant about the need to focus on strong balance sheets and well covered cash dividends. Bond yields are still uninviting and, as with cash deposits, returns are negative when translated into real terms (i.e. after stripping out inflation). We continue to believe that higher yielding blue chip equities remain one of the best places to invest money for total return in an increasingly uncertain market environment.

Momentum has carried through into the final quarter of 2010 encouraged by the second round of Quantitative Easing in the US. The similarities with the stock market rally in the early years of the 21st century are uncanny. Then, equities rose on the back of low interest rates and easy credit. This led to a credit bubble, the collapse of which nearly brought the global banking system to its knees. Today, the easy credit has gone but low interest rates remain and conventional monetary stimulus has been replaced by the latest round of $600bn spending by the Fed in an attempt to pump prime a lacklustre US economy. This is a high risk strategy. No one knows for certain whether such stimulus will work or what the longer term consequences will be. In our view, the outcome should provide a lift to the market but the consequences are likely to be a combination of higher inflation and a weaker US Dollar. This would be politically and economically desirable for the US economy, whose export market will receive a boost whilst simultaneously providing support for asset classes such as equities, precious metals and property prices. It will, however, not be good for US bond markets, particularly at the longer end of the yield curve. As a consequence, we are very underweight fixed interest bonds in the portfolio, holding a single short dated issue and two inflation linked government bonds. We remain very wary of this sector, inflation proofed issues aside. Investors looking for yield should continue to look towards quality equities to provide an alternative income stream to bond markets with built in protection against inflation. It rarely pays to 'fight the Fed' and with GDP and manufacturing data continuing to improve, we believe that this equity market rally has some way to go. The recent US mid term elections have proved to the incumbent Democrats that the voting public are interested in the economy first and foremost and we expect the Obama administration to stop at nothing to make things happen before the next presidential elections in 2012.