There is no question that equities have been facing short-term economic headwinds, which has been reflected in recent weaker equities markets across the globe. On the US front, disappointing first quarter economic data and the end of the second quantitative easing program in the US has created uncertainty about the robustness of the recovery. In Europe, policy makers continue to grapple with working out ways of containing sovereign debt problems and in China the authorities continue to try to tighten the money supply to contain inflation, while also contending with higher food prices.

On the domestic front, the local economy continues to face headwinds with most domestic based companies citing extremely challenging conditions. The prospect of further interest rates hikes over the next few months has tempered recently but the tone of the central bank nonetheless remains hawkish. While the overall valuation of the Australian share market remains attractive, there is a sense that earnings consensus numbers for 2012 are on the high side and so there is broad expectation of further downward earnings revisions, particularly in domestic cyclical stocks.

While we have positioned our Australian equities portfolio to reflect these risks, we think that some of the headwinds will be temporary. In particular, the effects of the floods in Queensland have persisted more than first anticipated and have had a short term dampening effect on economic growth, which was reflected in softer March quarter economic data. However, this issue should not disguise the fact that there remains a wall of work in the resource sector which provides investment opportunities across a variety of different businesses in the Australian stock market. Similarly, with regard to the US, we think that the recent weak March quarter data reflects the more temporary effects of higher oil prices and in particular the knock-on effects of the Japanese earthquake, which has reduced activity in the US auto industry. Several members of our team have visited the US recently to meet with companies from a range of industries and our view is that while issues remain in the financial and housing sectors, the corporate sector is in general well financed and more optimistic than the headlines might suggest. Investment from the corporate sector will be important in driving growth and there are some sectors, such as the very large energy industry, where business activity is clearly ramping up.

On the Fixed Income side, the bias is to continue to position portfolios from the long-side in bonds especially as the short-base in the market still exists. Looking forward, the medium-term concerns about the fiscal situation in the US still exist but the political landscape is becoming clearer with Obama looking much more of a certainty for a second term than just a few months ago.

We are positive on credit markets in the medium to long term. Even with generally soft US economic data over the last month, leading indictors are still weighted to the positive, balance sheets are strong, earnings continue to improve, equity volatility is low, defaults are falling and valuations are appealing on a historical basis. However, we continue to be concerned about the European peripheral sovereign crisis and the impact on credit spreads. Significant fiscal austerity measures in many Euroland economies will weigh on economic growth in the region. Peripheral sovereign bond holder haircuts are likely and concerns over this continue to weigh on markets.

Fund Manager Commentary