Global equities enjoyed a record breaking 3Q building on the strong returns that were witnessed in the Q2 2009 due to further strong corporate earnings and expectations that the Western industrialised economies might exit recession more swiftly than previously expected. The FTSE 100 (+21%) recorded its greatest quarterly increase since its inception in 1984. The combination of economic revival, coupled with upgraded corporate earnings expectations, has served as a heady cocktail for global equity markets which have now achieved a total return in excess of 50% from the 8th March lows. Aggressive equity index performance has taken equity valuations somewhat ahead of perceived “fair value” and much now depends upon the corporate sector’s continuing ability to drive profits growth to justify the rating. In large part, the revival in aggregate profitability should be driven by the recovery in the banking sector. Elsewhere, a reliance on cost cutting and working capital improvements may be insufficient to maintain, or build on, prevailing margins over the medium term, particularly given the lack of final demand by consumer and cuts in governmental spending. Whilst Western economic activity has recovered, the durability of that revival is questionable and a “double dip” recession cannot be ruled out in 2010 / 2011. Headline inflation is expected to begin rising over the autumn, although core inflation is expected to remain anchored. The key threat to financial markets lies in the anticipated timing of any interest rate hikes. Furthermore, an active debate regarding government spending is already underway, quantitative easing may be reversed in due course and banks’ capital adequacy ratios may be raised It may well be that the only course of action for deeply indebted nations to pursue is to create inflation. It is not expected that such a decision will be reached easily and implications for financial markets will be significant. In the meantime, however, the equity revival is expected to continue, boosted by resurgence in cross-border M&A such as the Kraft approach for Cadbury’s. The best performing major UK equity sectors in Q3 were once again the cyclical sectors such as the banking sector and mining sector. The FT Banking sector index enjoyed a near 40% increase with Lloyds (+47%) RBS (+40%) and Barclays (+28%) all benefitting from the sharp return of confidence in the sector. Extremely loose monetary policy, as stated in our last quarterly report, is continuing to support the profitability of banks. The insurance sector saw strong gains due to the £1.9bn agreed bid for Friends Provident (+40%) from Resolution and rumours of an approach for Legal & General (+52%). Mining stocks benefited again from further rises in commodity prices. Fresnillo, the silver miner, (+48%) and Vedanta (+47%) led the charge. Even the defensive sectors such as Tobacco and Food enjoyed strong quarters with Cadburys (+53%) sharply higher due to a bid approach from Kraft.

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