A Greek tragedy

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					A Greek tragedy

        First Quarter in Review
             Global
             Local
        Asset Class Return


The “Great Recession” of 2008 left a lasting indent on the global economy. Who would ever have
imagined that sovereign risk would become a developed market instead of an emerging market
concern? The first quarter of this year was characterised by sovereign risk issues. Budget deficits
and debt levels came to the forefront and peripheral Europe was branded by acronyms that
pertained to farm animals. The problems in peripheral Europe brought the future of the Euro zone
into question, but while some of the developed countries struggled with their structural
weaknesses, the recovery in the rest of the global economy continued to accelerate. The
acceleration in China has been so strong that concerns have cropped up over policy tightening and
the consequential slow-down in economic growth. Amidst all of these concerns, global liquidity
remained bountiful, interest rates low and inflation of little concern, setting the perfect backdrop
for financial markets to climb the “wall of worry”.

The US economy emerged from the financial crisis in a much better shape than what was initially
anticipated – the result of immediate and vast government intervention. The US economy grew by
5.6% during the last quarter of 2009, reflecting an upturn in business investment and a reduced
rate of inventory draw-down. The improved economic conditions prompted the US Fed to withdraw
some of the extraordinary loose monetary policy measures and they raised the discount rate from
0.5% to 0.75%. This is the rate at which the Fed lends to banks. The news initially rattled financial
markets as this was seen as a precursor for tighter monetary policy, but the Fed’s rhetoric that
they remain committed to leaving the official rate at an “extraordinary low” level for an “extended
period of time” stabilised financial markets.

                                           US GDP growth






                    Q2 2008   Q3 2008   Q4 2008   Q1 2009   Q2 2009   Q3 2009   Q4 2009

        Source: U.S. Bureau of Economic Analysis

The US employment backdrop has been a headwind to recovery in the consumer sector. The
unemployment rate has remained elevated at 9.7% and hides the fact that many discouraged
workers have left the labour force. Non-farm payroll data initially disappointed, but fears of a
jobless economic recovery were quenched by the March data which indicated the single largest
monthly employment increase in three years.
A turnaround in the job market should be signaled by the 162 000 jobs that were created in March
and the improvement in employment should help the beleaguered housing market. The loss of
income due to unemployment has been cited as the main reason for loan modifications in the US.
These have been necessary to stem the slide in home foreclosures as 25% of all mortgages are in
negative equity. Foreclosures as a percentage of total loans outstanding are at an all time high of
close to 5%.

                               US non-farm employment change '000







        Source: INet

The robustness of US corporate earnings has been one of the biggest surprises during the quarter
as they have, in general, beaten analysts’ expectations. Strengthening business activity, high
productivity growth, low interest rates and strong balance sheet conditions outside of the financial
sector all contributed to the surge in earnings growth. Indeed, corporate liquidity is at its highest
level since 1956! The financial sector has been able to restore profitability, but President Obama
has acted to tighten bank regulation, which poses uncertainties in terms of future profitability.
Proposed changes include scaling down on the risk that banks can take and splitting larger banks
up into smaller operational units.

In contrast to vastly improved economic conditions in the US, Europe is mired by structural issues
and a hawkish European Central Bank. The Euro zone grew by a paltry 0.1% during the last
quarter of 2009. France grew by 0.8%, Germany ended flat while debt-ridden Portugal and Greece
both contracted by 0.8%. It was debt concerns surrounding Greece that caused periodic bouts of
risk aversion in global markets during the quarter. In the end, a safety blanket was created by the
European Union in conjunction with the IMF. This involves a combination of IMF support and
bilateral loans from other Euro area states in the event that Greece can no longer tap the bond
market or foreign banks for funds. This action was necessary to prevent systemic risks as Portugal
also received a credit rating downgrade from Fitch due to its large budget deficit and high public
debt level. Portugal’s budget deficit of 7% of GDP might be small compared to Greece’s 16%, but it
is more than double the Maastricht Treaty’s 3% maximum level. In addition, Portugal’s external
debt amounts to 220% of GDP and its current account deficit stands at 10% of GDP. All of the
concerns surrounding Europe caused the euro to depreciate further and it lost 5.7% of its value
against the dollar over the quarter.

China has raised its bank reserve requirements since the start of the year in an effort to curb
excessive credit lending, restrain inflation and to prevent a property bubble from forming. Credit
extension during January alone was more than what took place during the whole of the fourth
quarter of 2009. Chinese inflation hit a 16-month high of 2.7% in February – ahead of analysts’
expectations. China has also come under scrutiny and tensions have intensified due to its currency
peg against the dollar with some US officials wanting China to be declared a “currency
manipulator”. The currency’s peg against the dollar has been in place since 2008 and has caused
artificial weakness in the Renminbi, making Chinese exports more competitive. Japan has found
favour from strong demand emanating out of China, which allowed the economy to expand ahead
of expectations. However, Japan’s domestic orientated economy remains weak and is still caught in
a vicious deflation trap.

Positive corporate earnings surprises buoyed investor risk appetite during the quarter. The US
Fed’s commitment to keep interest rates low for an extended period set the bull rally forth after a
brief sell-off during the second half of January. The MSCI Global Equity Index rose by 2.7% over
the quarter, pushing the Index 49.1% higher than what it was a year ago - keeping in mind that
financial markets bottomed out a little bit more than a year ago on 9 March 2009. Emerging
markets lagged developed market performance over the quarter and ended only 2.1% firmer.

But on a twelve month basis emerging markets have delivered a stellar return of 77.3%. The
Japanese Nikkei Index, one of the laggards during last year’s bull rally, benefitted from a weaker
yen exchange rate and closed 5.2% higher over the last three months.

                                 Equity market performance
                          MSCI Global Equity Index
                          MSCI Emerging Market
             160          Index





             2008/12/31    2009/03/31     2009/07/01   2009/10/01   2010/01/01   2010/04/01

       Source: INet

Fixed interest investors had to endure a mixed quarter, contending with deteriorating public
finances and sovereign risks while, on the positive side, credit products benefitted from a search
for yield and non-existent inflation pressures The JP Morgan World Government Bond Index lost
1.1% over the quarter. The US 10-year government bond yield ended the quarter flat at 3.8%, but
touched a low of 3.55% mid-quarter. The widening of yields at quarter-end was a result of the US
Treasury failing to attract buyers and the expiration of the Fed’s quantitative easing program.
Corporate bonds continued their out-performance over government issues since corporate finances
have been more conservatively managed than public finances, putting them in a better position to
successfully weather the economic downturn.


The South African economy has entered a Goldilocks environment – one that is not too hot, nor too
cold. It thus came as a surprise that the Monetary Policy Committee of the Reserve Bank cut
interest rates to a 30-year low of 6.5% on 24 March, after having kept rates steady since August
2009. Although recent inflation data surprised on the low side, the Reserve Bank’s rhetoric for
loosening monetary policy left economists scratching their heads. The Reserve Bank’s actions
raised questions about a change in mandate or even some political interference. Regardless of
what influenced the decision, monetary policy has been pro-cyclical instead of counter-cyclical as
we have already witnessed accelerating domestic economic activity. Economic activity for the last
quarter of last year again surpassed economists’ expectations when it grew by a healthy 3.2%,
lifting the economic decline for the year to -1.8% from 3.7% growth achieved in the previous year.

                                            SA GDP growth


                                1.3%                                    0.9%




                     Q2 2008   Q3 2008   Q4 2008   Q1 2009   Q2 2009   Q3 2009   Q4 2009

       Source: South African Reserve Bank

The recovery in the local economy has been driven by an acceleration in manufacturing, which has
benefitted from inventory replenishment and renewed demand for exports. However, the
manufacturing sector was the most severely affected by the economic downturn which means that
recovery is off a very low base. The Purchasing Managers Index, a leading indicator for the
manufacturing sector, has rebounded strongly, but recent manufacturing activity has been short of
expectations. Importantly, a gradual recovery is being witnessed in domestic demand as the
effects of last year’s interest rate cuts are felt in the broader economy. The Reserve Bank’s
Quarterly Bulletin also surprised positively with respect to the current growth momentum,
indicating strong external demand and improving domestic demand. It revealed a recovery in the
consumer sector and a rise in real disposable income. The household debt ratio increased as
households continued to dissave.

The business confidence indicator experienced its biggest single increase in 16 years and, together
with improving consumer confidence data, corroborated the upturn being experienced in the retail
sector. Consumer confidence data indicated that consumers are finding the current time better to
buy durable goods. Retail sales have steadily improved to -1.7% on a year on year basis, but with
a positive acceleration during recent months. It is not only retail sales that has benefitted from a
lagged effect in the reduction of interest rates, but house prices have also turned the corner with
positive yearly returns in recent months. Vehicle sales have leaped since the start of the year, but
the figures are off a very depressed base. Car fleet demand ahead of the Soccer World Cup has
been one of the key drivers of the upturn in vehicle sales. Although hesitant, more signs of a
recovery in domestic demand have thus appeared.

The new Minister of Finance, Pravan Gordhan, delivered a stable and pragmatic Budget Speech in
February, with no shift away from current economic policy. His speech held no surprises and
through prudent fiscal spending efforts, he reduced the budget deficit to 7.3% of GDP. The
government has benefitted from better-than-expected revenue performance recently, which will
help to further shrink the deficit. This could result in even lower government borrowing
requirements. Following the Budget Speech, the Finance Minister wrote to the new Reserve Bank
Governor noting that the Reserve Bank should be flexible in its monetary policy. This came after
the Reserve Bank left interest rates unchanged in the January meeting, when it noted that this was
not a unanimous decision with some members calling for a cut based on the growth outlook.

Inflation has decelerated at a faster pace than what was expected. The February figure of 5.7%
dipped below the Reserve Bank’s upper target of 6% due to a moderation in food prices. This,
together with NERSA’s decision to limit Eskom’s electricity tariff increase to 24.8% probably gave
the Reserve Bank the window of opportunity to cut interest rates further. The Reserve Bank did
note that recent rand strength had acted to tighten monetary policy and that high administered
prices had tightened financial conditions. The Reserve Bank’s forecast for inflation is that it should
average 5.4% during 2011. Lowering interest rates did not have the desired effect of depreciating
the rand, with the currency strengthening after the rate cut. The rand closed the quarter at R7.29
against the dollar – an appreciation of 1.5% over the quarter and 23.9% over the last year. The
local currency fared even better against the other major currencies, strengthening by 6.9% against
the pound and 6.3% against the euro over the quarter. The rand has been well supported by an
improvement in the current account deficit which reduced to 2.8% of GDP.

                                   Interest rate and inflation
              18                             Repo rate
                                             CPI Headline inf lation
                Dec-01   Jan-03   Jan-04   Jan-05   Jan-06   Jan-07    Jan-08   Jan-09   Jan-10

        Source: INet

The domestic equity market had a good start to the year with support from foreigners who have
been net buyers of R10.5bn worth of equities since the start of the year. It was especially the
strong returns achieved during March that pushed the FTSE/JSE All Share Index out of negative
territory to provide a positive return of 4.5% over the quarter. This translated into a 12-month
return of 44.1% or a stellar 89% in dollar terms over the same period. The quarterly returns were
led by a surge in the financial sector, which rose 9.9%, while industrial and resources shares rose
by 3.6% and 2.1% respectively.

A marked change in sentiment towards the bond market happened during the quarter. Not only did
local institutional asset managers rotate out of money market investments into bonds, but
foreigners were also keen buyers of fixed interest investments to the tune of R15bn. Foreigners
took advantage of a stable to stronger currency and a decent yield pick-up that was available in
the domestic bond market. After last year’s decline, the All Bond Index started to advance on news
of a possible interest rate cut and improving inflation data. News of a better-than-expected budget
deficit and the eventual interest rate cut in March acted to add fuel to the index’s advance. Listed
property took its cue from both an improving bond and equity market to gain 9.9% over the
quarter. The strong quarterly gain lifted listed property’s 12 month return to 27.1%.

The chips are falling into place for global economic momentum to continue gathering pace. Those
sectors that were the hardest hit at the onset of the recession have in general been the first ones
to recover. Global exports have shown swift recovery after a deep contraction. Manufacturing and
consumption expenditure have followed the profile of previous recoveries after recessions and
capital investments have been improving. Unemployment has shown more signs of having
bottomed out, with bank lending the only outstanding indicator that has yet to improve. However,
following a financial crisis inactive bank lending should be expected to unfold slowly. Over the
longer term, the current recovery should result in a two tiered global economy, divided between
emerging and advanced economies.

The developed world will languish under its indebtedness and high budget deficits. Fiscal drag and
lasting damage that the financial crisis inflicted on the supply-side of developed economies will
result in those economies having lower potential economic growth rates than what they had in the
past. In contrast, emerging economies have exited the recession in a much healthier state. The
speed and depth of the adjustment of the global economy toward emerging countries at the
expense of developed countries might just surprise consensus expectations in the near future.

The recovery in developed economies remains fragile, however, and the unwinding of interest rate
policies will be key to whether a double dip economic scenario can be avoided. Fortunately, global
inflation is low and there are very few inflationary pressures. There is hardly any credit lending that
could result in demand-pull inflation and the US Fed has given its commitment to keep interest
rates at a “very low level” for an “extended period”. In Europe, deflationary pressures due to
structural issues will keep the European Central Bank side-lined for a long time. Low interest rates
should help consumers to deleverage in the US, the housing market to recover and companies to
employ again. The US government’s control of nearly 80% of the outstanding mortgage market
should help to stem the massive wave of home foreclosures and help delinquent home owners to
modify their loan repayments. If the glut of home foreclosures can be prevented, then the
stabilisation in US home prices should be sustainable.

                                       Global Interest Rates

        Source: INet

In a low interest rate environment, with soft economic growth and low inflation, equities should
perform well. In the US, profit margins have come off their unsustainable highs and are now back
to levels below their historical mean. Corporate productivity and cost savings have improved to
such an extent that company earnings have consistently beaten analysts’ expectations. Moreover,
currency adjustments have made companies in countries that were struggling, more competitive.
This was initially evident in the US, but has broadened to the UK where sterling has lost a great
deal of its value. Equity valuations are not cheap any more, but neither are they very expensive.
The recent strong run in capital markets has made share prices vulnerable to a possible short-term
pull-back, but we believe that central banks’ reflationary policies will support share prices in the
near term.

The developed world’s public sector debt hangover will have a lasting longer term effect on the
global sovereign bond market. Huge fiscal deficits will have to be financed through the larger
issuance of government bonds. Already Greece has been struggling to refinance its debt. The
European Union/IMF rescue package will relieve pressure on Greece, but it will also bring tough
conditions Larger issuance will push government bond yields higher, tilting this asset class into a
secular bear market, although in the near term yields will be anchored by low interest rates and
immaterial inflation rates.

A fear for the US treasury market should be China’s dwindling holdings of US treasury debt. China
has significantly reduced its holding of US treasuries and diversified its reserves. Our preference
remains for corporate bonds because corporate health is improving and where still decent yield
pick-up can be obtained together with a further decline in default rates and the possibility of
spread narrowing.

Local economic conditions are fast improving alongside the acceleration in global growth. The initial
upturn in manufacturing activity is now joined by a broader based recovery. The leading economic
indicator has been rising steeply with only one component currently negative – that of money
supply. The rise in business and consumer confidence bodes well for these two sectors. Indeed,
conditions for consumer spending continue to improve thanks to still strong momentum in equity
prices, the recovery in the housing market, falling inflation (particularly in food) and elevated
nominal wage gains. It has become tougher to gauge the Reserve Bank’s actions, but another
interest rate cut should probably not be ruled out due to persistence in the strength of the currency
and decelerating inflation.

The domestic equity market has had a phenomenal run in both rand and dollar terms over the last
year. This does leave the market expensive from a price-to-earnings valuation perspective, but fast
improving corporate earnings and a healthier domestic economic environment should leave the
equity market well-supported. In addition, the Reserve Bank’s accommodative stance should
benefit both company earnings and equity valuations. Foreign interest in the local equity market
should remain as international investors continue to accept higher risk investments, as has been
evident in continual foreign portfolio inflows into the country.

                                   JSE All Share PE Ratio







              Jun-95    Jun-97   Jun-99    Jun-01    Jun-03   Jun-05    Jun-07    Jun-09

        Source: INet

The bond market has, and should continue to, benefit from lower interest rates and decelerating
inflation. Many bond market related risks have started to wane. The budget deficit is starting to
improve due to better revenue collections. Inflation has been decelerating at a faster pace than
what was anticipated and NERSA’s electricity tariff decision has helped to anchor inflation
expectations. Offshore investors have also found domestic bond yields attractive on a relative
basis. Compared to the yields on money market investments, bond yields are looking attractive
and provide the opportunity for additional capital gains.

                                                    3        6        12
                                      Level       Months   Months   Months

Headlines Indices

Africa All Share                      3,250.11     4.48%   16.43%    44.09%

Africa Top 40                         2,932.49     3.82%   16.79%    42.59%

Africa Mid Cap                        6,138.31     8.74%   14.80%    54.40%

Africa Small Cap                      7,492.94     5.49%   12.43%    44.60%

Africa Fledgling                      5,142.85     1.32%    4.53%    41.90%

Africa Resource 20                    2,583.36     2.09%   19.12%    36.01%

Africa Industrial 25                  3,535.85     3.63%   13.47%    49.27%

Africa Financial 15                   3,171.34     9.85%   16.97%    52.49%

Africa Financial and Industrial 30    3,358.61     5.73%   14.78%    49.85%

Africa Capped All Share               18,436.34    4.51%   16.33%    44.94%

Africa Shareholder Weighted           7,797.43     5.16%   14.59%    43.20%

All Share Economic Group

Africa Oil & Gas Index                2,155.9      1.59%    9.47%    13.41%

Africa Basic Materials Index          2,733.8      2.58%   20.06%    40.77%

Africa Industrials Index              4,123.1      6.17%    6.57%    48.07%

Africa Consumer Goods Index           3,211.5      3.89%   23.34%    64.38%

Africa Health Care Index              4,199.1      5.08%   27.32%    65.34%

Africa Consumer Services Index        6,688.6      9.60%   20.39%    70.68%

Africa Telecommunications Index       7,697.5     -4.78%   -7.87%     7.39%

Africa Financials Index               3,390.4      9.87%   17.04%    51.28%

Africa Technology Index               2,318.6     15.36%   32.53%    85.66%

All Share Sector Indices

Africa Chemicals                      2,934.6      3.80%    7.40%    46.34%
Africa Electronic & Electrical
Equipment Index                       3,768.9      2.22%    4.81%    55.70%

Africa Industrial Engineering Index   6,700.2     14.82%   22.41%    73.91%

Africa Automobiles & Parts Index      1,988.3     46.23%   49.04%    72.60%

Africa Beverages Index                3,311.3     -1.00%   19.38%    55.59%

Africa Food Producers Index           5,477.8      6.78%   15.29%    34.86%
Africa Health Care Equipment &
Services Index                        6,242.4     -0.52%   27.25%    55.95%
Africa Pharmaceuticals &
Biotechnology Index                   10,542.2     8.53%   26.89%    71.64%

Africa General Retailers Index        7,945.6    17.11%   20.97%    66.64%

Africa Travel & Leisure Index         5,862.0    -0.62%    6.78%    30.70%

Africa Media Index                    18,304.6   5.61%    23.09%    93.65%

Africa Support Services Index         3,658.7    7.31%    18.60%    61.12%
Africa Industrial Transportation
Index                                 3,388.4    9.61%    23.87%    79.08%

Africa Food & Drug Retailers Index    10,891.8   9.52%    18.41%    53.49%
Africa Fixed Line                                               -
Telecommunications Index              4,698.2    -8.81%   20.99%     -2.35%

Africa Banks Index                    4,937.9    12.25%   20.34%    56.07%

Africa Non-life Insurance Index       2,996.2    -2.90%   19.05%    40.37%

Africa Life Insurance Index           1,934.4    6.91%    17.33%    67.35%

Africa General Financial Index        4,970.0    15.65%   15.76%    60.65%
Africa Equity Investment
Instruments Index                     3,533.8    2.94%    17.81%    42.54%
Africa Software & Computer Services
Index                                 1,685.0    15.36%   32.53%    85.66%

Africa Gold Mining                    1,015.5    -8.20%   -9.30%    -19.38%

Africa Platinum & Precious Metals     2,866.1    2.08%    20.12%    45.09%

Africa Property Unit Trusts - (PUT)   6,120.8    9.03%    15.57%    32.24%

Africa SA Listed Property - (SAPY)    737.2      9.86%    14.31%    27.07%

Bonds, Cash & Inflation

All Bond Index                        312.3      4.45%     5.57%     9.01%

Stefi Composite                       238.6      1.78%     3.66%     8.15%
CPI - New Headline (Previous
Month)                                110.2      1.19%     1.57%     5.66%
CPI - History Rebased (Previous
Month)                                           1.19%     1.57%     5.66%


Rand Dollar Exchange Rate             7.29       -1.48%   -2.98%    -23.86%

Rand Pound Exchange Rate              11.05      -6.90%   -8.10%    -19.34%
Rand Euro Exchange Rate               9.83       -6.31%   10.56%    -22.07%

Dollar Euro Exchange Rate             1.35       -5.71%   -7.73%     2.17%

Dollar Yen Exchange Rate              0.01       0.00%    -3.60%     5.94%

Niara Dollar Exchange Rate            149.70     1.57%     1.84%     1.66%

Commodity Prices

Brent Oil (USD/Barrel)                81.20      5.18%    21.56%    73.73%

Gold (USD/oz)                         1,113.6    1.53%    10.54%    21.14%

Platinum (USD/oz)                     1,644.0    11.87%   26.66%    45.62%

Copper ($/Ton)           7,830.0   6.59%    27.61%   94.05%

CRB Index                273.3     -3.54%   5.38%    24.02%

Global Bonds & Equity

Global Bonds (R)                   -2.53%   -5.85%   -19.41%

MSCI Global Equity (R)             1.22%    3.35%    13.52%

Global Bonds             450.2     -1.07%   -2.96%    5.84%

S&P 500                  1,169.4   4.87%    10.63%   46.57%

Nasdaq                   2,398.0   5.68%    12.98%   56.87%

MSCI Global Equity       1,200.5   2.74%    6.53%    49.09%

MSCI Emerging Mkt        1,010.3   2.11%    10.53%   77.26%

FTSE                     2,910.2   5.41%    10.45%   48.56%

DAX                      535.6     3.80%    8.35%    53.49%


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