(Prepared March 2010)

World equities markets reacted sharply negatively during January to the concerns that Greece may default on its very large debt and create a second wave of financial crisis across the European Union.  Volatility and degrees of uncertainty for investment markets are likely to be a constant throughout 2010.  the major European economies of Germany and France have stabilised the situation however, other European countries including Spain, Portugal and Italy are all dealing with large debt issues, which has created the recent uncertainty in global markets.

Underlying economic conditions globally are generally showing signs of improvement and markets are well positioned to benefit from a more stable economy (particularly in Australia) over the coming year.  The rebound has been largely fuelled by the massive injection of liquidity and the aggressive fiscal stimulus by governments globally.  Governments will need to carefully consider the implications of winding back the massive stimulus over the coming year.

Confidence should be the key driver of equities and property markets over the coming year.  The recent events in equities markets suggest that investors with a longer-term focus are likely to benefit from the current market conditions.  Companies worldwide have had time to repair balance sheets and cut debt and overall costs leaving them in a generally healthy state to generate solid returns over the coming year.

The Australian equities market is starting to factor in the strong sentiment of a more stable economic environment.  The recent reporting season provides the platform for greater confidence as the major miners and banks have all reported strong results.  Overall sentiment and confidence is likely to be much improved at the company level.

Although the global developed economies with the exception of Australia still remain fragile, burdened by high unemployment, high debt and subdued credit growth, there are however, signs of resilience.

Asia and the emerging markets continue to provide the catalyst for growth.  India and China have been stand out performers over the past year and should continue to underpin world growth during 2010, although with periods of uncertainty.  With the Chinese and many Asian currencies closely tied to the weak US dollar this may create undue pressure and the potential for a “currency crisis” in the region.  The Japanese economy continues to remain weak and is not preferred in the current environment.

Opportunities for the Australian equities market appear to be solid with banks, resources and cyclicals all generally well positioned as we lead into a more stable environment in Australia.  Demand for materials and energy continues to be strong.  Margins for the banks remain high and quality companies with low debt and strong balance sheets should be well positioned for the year ahead.  Listed property funds should also perform satisfactorily in this environment, especially after many have recapitalised and reduced debt significantly.  Commercial and retail property valuations are starting to bottom and long term investors are likely to slowly re-enter the market over the coming year as access to relatively cheap debt and low valuations should make property more attractive for the next cycle.

The direction of interest rates in Australia is likely to continue to be up as the economy stabilises.  The government deficit and resulting increase in issuance of bonds is likely to limit opportunities for the fixed interest markets over the coming year.  This should be offset to a degree by the rising yields as rates increase.  The cash rate is currently 4.00%.

Global developed markets are unlikely to see interest rate rises for at least the next quarter and the US is likely to see rates at the current low levels for much of the coming year as they deal with their high debt and high unemployment levels.  The global financial environment, while improving, continues to be burdened with limited credit availability.  This is still hampering pockets of the credit markets and the global banking system from functioning freely.

The major impediment to a more normalised market is the rationing of debt funding by banks and financial institutions.

Investors should now be focusing cautiously on opportunities in this environment, as valuations for quality securities in both equities and credit are generally attractive on a medium term basis.

In looking ahead there is the potential for significant investing opportunities, however, the need to deal with uncertainty, tread carefully, focus on high quality companies and strong balance sheets still remain the key. 

Major themes include  

• Energy - with oil in the US$80/barrel region, supply is still challenged both in the short and long term. 
• Economies are starting to recover.  Identify the companies that will recover early. 
• Resources – demand for resources is unlikely to go away.  The supply side has been reduced in the downturn.  Lead times are generally long in this sector.

International Shares:    (Overweight)

Global share markets have digested the worst of the economic news and markets are now showing signs of recovery.  While volatile, opportunities should present over the coming year in this sector.  Looking forward on a three-year outlook the favoured areas are Asia and emerging markets.  Stock and country selection is going to be much more important over the coming year as volatility remains high.

Australian Shares: (Overweight)           Australian Small Caps: (Neutral)

The underlying market fundamentals have improved markedly.  Investors should focus on quality in this environment.  We consider overweight appropriate on a three-year outlook for the large cap sector.  Also, managers with strong stock picking skills are expected to out perform.  Small caps have rallied strongly but the focus should be on quality companies with strong income streams.  Funding and liquidity still remain a key issue.

Australian Listed Property: (Underweight)        Global Listed Property: (Underweight)

Property is likely to under perform equities on a three year outlook and suggest under weighting the sector.  Quality direct property valuations are starting to show signs of recovery although likely to be slow as access to funding remains difficult.  The listed property sector has undergone significant recapitalising during 2009 and opportunities are likely to emerge over the coming year.

Fixed Interest: (Neutral)

With the direction of interest rates in Australia likely to be up, opportunities for fixed interest are likely to be limited over the coming year.  With a high A$, opportunities for hedged international rates are also likely to be limited over the coming year and an underweight for the sector is appropriate.  The credit market should provide selected opportunities over the coming one to three years as credit spreads contract further and investment grade credit becomes more attractive.