Sub prime concerns & risk aversion encouraged a flight to safety in the 3rd quarter, with volatility rising dramatically as the VIX climbed to its highest level in 4 years. By mid August the MSCI had fallen 8% but the subsequent rally has been re-assuring, although the magnitude of strength did take us by surprise. In this regard the index rebounded 11.2% from its intra month low to end the quarter in positive territory (USD +2.5%) & bringing the YTD gains to 11.7%. The greater than expected rate cut by the Fed, coupled with a consensus view that rates globally have peaked ignited the rally. Within developed markets Asia continued to offer the best returns during the period under review followed by the US, Europe & then Japan. Our overweight position in Asia therefore added alpha as did our underweight position in the US. Conversely the tilt to Europe detracted from returns. Dollar returns (+3%) were diluted by the strength of the rand, which was up 2.6% against the greenback. Over 12 months our overweight position in growth stocks has contributed to our massive out performance (9.8% vs. 3.5%). As we enter the 4th quarter, we retain our positive outlook for shares. In addition to their favourable valuation, we believe the environment favours them due to rising liquidity & strong balance sheets. The shrinking equity float as a result of record share buy backs & declining new issuance reinforces this view. Clearly the risk of complacency amongst investors & corporate earnings surprising on the downside are concerns, while a correction is also possible as the current bull market (MSCI 170% over 260 weeks) exceeds the median duration (123 weeks) &magnitude (57%) of the past 8 cycles.

After being the worst performing currency last quarter the rand rebounded in Q2 to be one of the best performers gaining 3.4% against the US$. Fortunately this was offset by rising markets (MSCI +5.8%) as well as the outperforming its benchmark. Outperformance YTD can be attributed to our overweight position in growth stocks (USD +12.5%), which are rebounding against their value counterparts (USD +9.9%) as well as our emerging market bias, which outperformed developed markets. In this regard evidence of the global economy surprising on the upside has supported markets such as Brazil, India & China resulting in these regional funds being the largest contributors to returns. Within developed markets Asia continued to offer the best returns during the period under review followed by Europe, the US & then Japan. Our overweight position in Asia & Europe therefore added alpha as did our underweight position in the US. Conversely the tilt to Japan detracted from performance as did the Japan Smaller Companies Fund, which is struggling in a weak Yen environment that favours large caps.

We still believe the macro environment favours equities due to attractive valuations, rising liquidity & strong balance sheets. The shrinking equity float as a result of record M&A activity, share buy backs & declining new issuance vindicates this view. While relative valuations have retreated on the back of a rout in bond markets they remain supportive (earnings yields still above bonds). Clearly the risk of complacency amongst investors & corporate earnings surprising on the downside are concerns, while a correction is also possible as the current bull market (MSCI 123% over 195 weeks) exceeds the median duration (123 weeks) & magnitude (57%) of the past 8 cycles. We would use a correction as a buying opportunity as we would any further strengthening in the rand. Currency movements are a key driver of returns so it's worth noting that consensus forecasts 12 months out are calling for a weaker rand (ZAR/USD=7.39). This is in line with our view as SA's record current account deficit should weigh on the local unit; however in the short term flows on the capital account are offsetting this.

The rand started the year where it left off, being the worst performing currency in the world, as it declined 4.2% against the dollar in Q1 (over 12 months it has lost 15.7%). Currency weakness had the largest impact on portfolio returns resulting in it gaining 28.3% over 12 months. Global equities also assisted, with the MSCI starting the year in positive territory (USD +2.5%). While the portfolio outperformed its benchmark over 3 months, the 12 month return was behind benchmark.

This can be attributed to our overweight position in growth stocks (USD +11.0%), which lagged their value counterparts (USD +18.6%), as well as our small & mid cap bias, which underperformed large caps. In dollar terms, the MSCI Pacific (+4.7%) offered the best returns during the 1st quarter, followed by Europe, the UK, Japan & then USA. Our overweight position in Asia & Europe therefore added alpha, as did our underweight position in the US. The Australia & European smaller companies funds were the top contributors to returns, but this was offset by underperformance of the Japan smaller companies fund. Emerging markets continue to outperform, so the move to the broader MSCI All Countries Index continues to pay off. In this regard, the India & China Focus funds, as well as the Latin America fund, have been the top performers since their introduction 9 months ago. Looking ahead, STANLIB's view is the macro environment still favours equities, as inflation is less problematic, the breadth of growth is good & leading indicators have stabilised. We believe attractive valuations, abundant liquidity, robust M&A activity & strong balance sheets also remain a key underpin to the market.

While relative valuations have retreated, they remain supportive for equities over other asset classes. Record share buy-back programs vindicate our view that equities are not expensive. On the downside, we are concerned that investors have become complacent & there is a chance of corporate earnings surprising on the downside. A correction is also possible, as the current bull market (MSCI 140% over 237 weeks) exceeds the average duration (141 weeks) &magnitude (84%) of the past 8 cycles. Wewould use this as a buying opportunity.