1 On a prospective p/e ratio of below 14 times 2010 earnings, well below fair value of around 16, global equities remain very good value.

2 Earnings forecasts continue to be upgraded with over 60% of estimate changes positive. Analysts have responded cautiously to third quarter earnings which were well ahead

of expectations, so significant upgrades of the next few quarters’ earnings are almost inevitable. Initial estimates already pencil in mid teens earnings growth for 2011.

3 Corporate profitability has withstood a severe economic downturn well, largely as a result of strong productivity growth. Not only have costs been cut but there are significant pay-offs coming through from past investment, particularly technology related. The US productivity growth in this recession has been by far the best for 50 years. There is a danger that an excessive focus on the risks will lead investors to ignore the positives.

4 Economic growth in 2010 and subsequent years in developed economies is likely to be modest, but that should make the expansion phase long and durable. If it is based on investment rather than credit expansion or government spending, the result should be a more stable global economy and, possibly, an increase in the trend rate of growth.

5 The collapse of communism 20 years ago sparked political, social and economic change throughout what was then known as the third world. The consequence is strong economic growth and sharply rising living standards in what are now known as the emerging economies. This process has much further to go. Concern about the relatively few failures and dysfunctional states should not detract from the success of the many.

6 The fiscal challenge facing the developed economies in financing and reducing huge budget deficits is severe, but the experience of Canada and Sweden shows that it is not insoluble, and the economic and social cost may be surprisingly easy to bear. Moreover, public opinion is behind such retrenchment.

7 Bond investors do not require immediate and drastic action; if presented with a coherent plan over several years, they are likely to be willing to finance continuing deficits at modest interest rates. Spreads between corporate bonds and government bonds remain generous, particularly since the default rate appears to have peaked.

8 Interest rates are likely to rise in 2010 but this is already reflected in market interest rates. Well over 3% can be earned on 3 month notice deposits in the UK and nearly all

new fixed mortgages are charging an APR of above 4% already. A rise in interest rates will be an indicator of a return to normality, and therefore positive. There are significant further returns to be made in 2010 and, potentially, for several years thereafter.

9 The scale of quantitative easing in the developed economies has been huge but it has only counteracted the contraction in bank lending, and so threatens little inflation for now. Productivity growth and high output gaps promise continued low inflation while the withdrawal of liquidity in due course will be feasible if governments gain the confidence of bond investors in their fiscal policies. Runaway inflation as a result of printing money is far from inevitable.

10 Oil supplies are finite but reserve estimates for natural gas have been rising strongly. High energy prices have encouraged greater efficiency and the nuclear industry around the world is undergoing a renaissance, reducing the pressure on fossil fuels. High base metal prices are leading to investment in mine expansion and encouraging more efficient usage. As genetically modified crops spread around the world, crop yields will continue to rise while the faddish diversion of grain to produce bio-fuels is on the wane. In short, higher commodity prices are restraining consumption, increasing output and encouraging increased productivity. Cost push inflation and mass starvation are not in prospect.

11 Investors are focused on the uncertainties and reluctant to take risks. Flows into equities from both retail and professional investors are low and the slightest wobble in markets sends investors running for cover. Investors are more worried about the downside than excited by the upside and euphoria about the gains this year is notably absent. Poor sentiment is a classic indicator that the gains will continue.

We at Admiral believe there are significant further returns to be made in 2010 and, potentially, for several years thereafter.

Peter Waller - Investment Director

Peter Waller - Director

The good news (such as it is) is that the UK index managed to close above the lows of the session on Tuesday, at 5250 or so, although the overall impression remains that prices have gone fairly quiet ahead of this week’s Fed meeting – not that any change in monetary policy is expected, although the accompanying statement will probably be more closely scrutinised than ever for evidence of even the subtlest change of emphasis. The key levels for FTSE traders remain at 5190 and 5395 or so.

Peter Waller - Investment Director

We have enjoyed significant rises in the markets since the bottoms seen in March (The FTSE100 fell to 3460).  The point has now been reached where investors are asking if current levels will break down.

Here are the views of one respected Technical Analyst I follow :-

For the FTSE 100 this morning is probably as much about consolidation again, after the flotation with intraday highs of the year yesterday. The hourly chart shows a rising trend channel in place since early last week with the floor of the channel running through 5220. The implication is that unless we see an end of day close below the November uptrend line there is little reason to imagine that will not be further upside for this market. Helping the bulls to remain confident is the way that we have finally got our golden cross between the black 200 period moving average and the blue 50 period moving average.

This is a buy signal in a classic technical sense, and it would be very disappointing/surprising if the signal failed.

It looks like more upside to come.

Peter Waller - Investment Director

 Market Movements

Key themes for the second quarter

Notwithstanding the mood change, there clearly remain some tailwinds for financial assets. Arguably, equities and corporate credit are both cheap. Global dividend yields are at their highest level for almost 30 years, while corporate credit spreads remain exceptionally wide, thus exaggerating the default rate that we are likely to see.

The global recession is not over but, arguably, the most intense phase is. Equity markets tend to recover maybe six to 12 months before there is strong evidence of economies turning and, given that we expect such an environment moving into 2010, it would not be an unlikely development for equity markets to continue to try to ‘sniff out’ a possible recovery in the coming months. Nevertheless, markets still face a number of strong headwinds.

The banking crisis is not over and is going to drag on into 2010. In the interim, it is quite likely that we will see further episodes of heightened volatility, maybe significant ones, over the next few months. Outside of the banking system, expect to see significant weakness in corporate earnings also. And, in thinking that we can return to the world of positive, rather than collapsing, economic growth, the speed of recovery is going to be slow, leaving us in a growth-challenged world not only this year, but also in 2010.

For all the concerns about inflation, because of what central banks and governments are doing, it is possible that the threat of deflation is likely to loom larger than the threat of inflation.

The implications for different asset classes

An important starting point in terms of investment policy is that cash rates are now effectively zero. This is a significant difference from where we were only 12 months ago.

Although government bonds offer poor value from a long-term perspective, with central banks being big buyers in the market, I think it is too early for material breakouts on the upside in terms of yields. Consequently, I think government yields will remain around their current level until we enter a more normal economic environment, which could take several quarters.

As mentioned above, there remains genuine value in corporate credit. While we see value across all corporate credit products, the returns in investment-grade credit are potentially such that there is no need to go too far down the risk spectrum at the moment.  We have been recommending this area for the past 6 months and it is still not too late to get involved.

In terms of equities, the bottoming-out process is continuing, but we do not expect markets to break the lows that they have been testing over the past six months. We believe there is some upside potential if the improvement in economic conditions is stronger than anticipated. Conversely, equities could be undermined by the feeble nature of any recovery, particularly following the recent price rally, and additional shocks in the financial sector.

Peter Waller - Investment Director

Equity, currency and bond markets measured from previous Friday’s close to Friday’s close. All index returns in local currency terms. All equity index returns are price only. *Bonds: 10-year yield.