International Equities

Overview
Over the quarter ending 31 March 2012, the MSCI World (ex-Aust) Index USD$ rose by 11.08%.

In our last update we wrote:

"Until a more comprehensive solution for the Eurozone problems is found we expect global markets to remain directionless. With Europe on the verge of a recession and the prospect of China slowing, it is very difficult to mount a bullish case for global equities despite reasonably attractive valuations."

The rally on global sharemarkets over the quarter shows how wrong we were. What we did not count on was the success of the ECB's Long Term Refinancing Operation (LTRO) where banks were offered cheap loans for 3 years. As stated earlier, the 3 year LTRO had the dual effect of reducing the short term risk of any EZ bank failures and also reducing sovereign bond yields and thus reducing the near term risk of a country default. LTRO's are nothing new – the reason this initiative worked was because of the longevity of the loan term, allowing banks to plan with greater certainty over a much longer time frame than normal (previous LTRO terms were only for 3 or 6 months).

Make no mistake – investors greatest fear had been an escalation of the sovereign debt crisis. The 3 year LTRO initiative almost single handedly eased those fears by more than we ever expected.

Outlook
The recent rally on global sharemarkets has been largely a relief rally as economic fundamentals otherwise remain mixed. The US recovery has very much justified a rally but it faces headwinds in the form of looming fiscal austerity to reduce the Government's enormous debt burden. China's economy has slowed well below trend and the Eurozone remains in or on the borderline of a recession.

Conclusion
The 3 year LTRO was no magic bullet but it has bought policymakers more time to try and address the fundamental problems that affect the EZ region. Given the enormity of the EZ problems, we remain sceptical of any significant success – this is because the measures required of debt reduction, structural reforms and growth are almost diametrically opposed. Fiscal austerity required to reduce debt does not go hand in hand with growth

In the short term we expect momentum to spur global markets higher, but without a solid economic footing a sustainable rally remains unlikely. As a result we recommend a moderate underweight exposure to this asset class over the coming quarter. In the short term we expect momentum to spur global markets higher, but without a solid economic footing a sustainable rally remains unlikely. As a result we recommend a moderate underweight exposure to this asset class over the coming quarter.

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