After a positive first quarter in 2010, the second quarter was a turbulent one.  The markets oscillated between “risk love” at the beginning of the quarter and “risk aversion” at the end of the quarter.  In April, strong equity markets and increased risk appetite were quickly pricing in a traditional “V” shaped economic recovery.  May, however, quickly became the opposite, as the markets rapidly moved 180 degrees to fear a relapse into a double dip global recession.  

I have written for some time that we must expect such volatility, until such time as investors finally recognise that the reality for the global economy and markets, over the next 5 years at least, is going to be a slow growth world as we pay back for the excesses of previous cycles. Such “new reality” means that for me, both April and May are incorrect extremes in markets and the fundamental reality lies somewhere in between.

The major event to shake confidence and markets in the second quarter was the Greek sovereign debt crisis, which subsequently broadened into a European sovereign debt crisis. A weak euro was the markets’ mechanism for highlighting the weaknesses of Europe. The ECB and governments responded with great resolve which helped underpin markets. However, markets were not completely comforted, and we are left with a strong debate as to whether the strong austerity measures being taken by governments will kill or cure the economic recovery in Europe. I believe that the correct steps are being taken and the result will be somewhat slower growth over the short term with a more positive medium term outlook.

·         Despite the quarter’s setback, most equity markets are still 50% or more above their lows of 2009

Our central scenario remains that we are just at the beginning of a global economic recovery and not the end, so no the recovery hasn’t ended! Over short term periods markets are driven by sentiment, both positive and negative, but over the medium term fundamentals matter, and our baseline scenario remains that the economic and market recovery remains on track and that this in itself will provide comfort to risk assets and reverse some of the risk aversion moves of the second quarter. If necessary central banks have the fire power to become extremely aggressive via quantitative easing should it be required

In managing portfolios, and particularly in such a volatile environment as we are in, discipline and patience are very much to the fore in our thinking. On a twelve to eighteen month time horizon, I continue to expect double digit returns from real assets such as equities and commodities. Over the summer months, it is most likely that markets will continue to struggle in a range bound manner, and should regain more positive momentum in the autumn and looking forward into 2011

I repeat our message that such a secular investment outlook requires a diversified portfolio of assets, country and sector exposures. Within portfolios I continue to favour emerging markets, high quality companies over poor quality and continue to emphasise dividend income as a very important component of total return.