Quarter Ended 31 March 2010

Markets showed positive returns for the first Quarter of 2010 as monetary easing remained in place and corporate earnings continue to beat expectations.  However, sovereign default risk poses concerns for equity market investors.

EU Macro
The Eurozone, and more particularly Greece, came to the forefront of investors concerns.  Greece's fiscal concerns received little sympathy from its European partners based on previous manipulation of economic data.  It seems a combination of Eurozone members and the IMF will provide a bailout of the Greek economy.  However, for the satisfaction of the bond markets a credible deficit reducing plan must be proposed and enacted.  The problems encountered by Greece could easily be replicated in other periphery Eurozone economies such as Portugal and Spain.

US Macro
Chairman Bernanke and the Federal Reserve have indicated that interest rates will continue to remain at exceptionally low levels for an extended period.  Corporate profits have continued to beat expectations based on significant cost cutting and relatively benign retail sales figures.  However, a concern for both the Fed and the Obama administration continues to be structurally high levels of unemployment.  The credit ratings agencies have given due warning to the US economy with regard to its AAA status.  The significant amount of stimuli both monetary and fiscal coupled with future liabilities, such as the retiring baby boomers, has assured that the medium-term target of reducing the fiscal deficit will need spending cuts or tax increases.  Whilst the fear that future assets bubbles or inflation may be created by the excessive stimuli there is enough spare capacity in the US economy to ensure that this is a medium-to-long term concern. 

UK Economy
International investors have been focussed on the upcoming General Election in the UK economy and more specifically the necessary steps that need to be taken to enact a significant reduction in the fiscal deficit position.  As with the US economy tax rises and spending cuts will be the likely instruments for a rebalancing.  Neither policy is considered favourable for votes.  The short-term fear is that the hung parliament as experienced in the mid 1970's which culminated with an IMF bailout could be repeated. 

Irish Macro
The austere budget enacted at the end of 2009 ensured that the Irish Government gained significant credibility from the bond markets.  This is reflected in the spread of the Irish 10 year bond against the German equivalent which has tightened significantly in comparison to other peripheral Eurozone economies that have suffered from excessive consumption.  Post the introduction of NAMA there is a suggestion that there may be GDP growth recovery at the end of 2010.  Statistically this may be the case as exports become a more important component of GDP figures, however, the sense of recovery may not be felt by the Irish consumer.

China
There is concern amongst investors that there is a Chinese property bubble and that inflation may be a risk for the domestic economy.  There is little doubt that China in future years will be a significant economic power, however, the process of industrialisation will entail considerable volatility.  A significant amount of GDP growth in 2009 and Q1 2010 was based on investment and government expenditure.  A rebalancing of the Chinese economy with greater emphasis on consumption could ensure more sustainable growth trends.

Wells Fargo
Over the quarter we opened positions in Wells Fargo, which we regard as a relatively defensive US retail bank.  The valuation was not stretched and the stock provided a defensive way to participate in the financials rally without exposing ourselves to the risks inherent in investment banks or banks involved with exotic products.  We were attracted by Wells Fargo's strong traditional banking franchise which was strengthened by the acquisition of Wachovia just over a year ago (the group has 70m customers and holds 10.8% of US deposits).  The deal gives the group the opportunity to generate cost savings and cross sell products to the enlarged customer base.

Synthes
Another stock purchased in Q1 was Synthes, the Swiss healthcare and medical devices group.  We were attracted by the stock's valuation (a 6% free cash flow yield) and its defensive growth characteristics.  Relatively stable end markets and a debt free balance sheet provide the defensive components, while demographics (ageing baby boomers) and new geographic markets (especially in Japan and emerging markets) represent the growth opportunities.  Overall, we see the attractions more than outweighing the potential threats from pressure on health budgets and product development issues.

CRH
Building materials group CRH remains a preferred holding.  A price to book valuation of 1x is attractive and it is supported by a 3.4% dividend yield.  The benefits from cost cutting and the full impact from stimulus spending will allow a meaningful improvement in earnings in 2010.  Meanwhile the group's strong balance sheet and free cash flow enable CRH to lead further consolidation in the sector, whereas competitors are relatively hampered by high debt levels.  This will allow CRH continue to add value through acquisition development, and it is one of few companies to have consistently done so over time.

Conclusion
Appian retains an overweight position in equities and cash based on relative value versus other asset classes and whilst we remain concerned with regard to the sovereign risk and the default of Government obligations, we believe in the short term that continued monetary stimuli will provide a favourable backdrop for the equity markets.

John Mattimoe
March 2010