Taken in isolation, the final quarter of 2011 would ordinarily be considered one in which markets have delivered strong returns for investors. Most global equity markets have seen positive returns with the developed markets of the UK and US among the strongest. However, this has to be considered in the context of the previous quarter which saw double digit losses in those same markets which have not yet been recovered. It also disguises the fact the quarter has continued to see extraordinary movements in the prices of assets and has remained dominated by the same macroeconomic issues that led to the major market correction through the previous quarter.

October saw a broad rally in equity markets with the S&P 500 recording its best monthly gain since December 1991. Hong Kong's Hang Seng index rose 11% in the final week of October alone. These rallies presaged a positive outcome at the much anticipated EU summit late in October where it was initially perceived politicians were committed to making progress on resolution of the Eurozone debt issue. In what has become a recurring theme, the subsequent policy detail failed to live up to the political rhetoric prompting a swift reversal in markets with the FTSE 100 falling over 6% within two days as we entered November. November then saw a volatile downturn in equity markets eradicating most of October's gains. As we headed towards December, the FTSE 100 saw nine days of consecutive losses for the first time in over twenty seven years. In the first half of December it was gold's turn with a 10% fall in price in two weeks raising doubts as to its safe haven status.

Market action across the period has also been heavily influenced by continuing concern that the outlook for global economic growth is declining and fears of a "hard landing" in China. These negative factors have however been offset by data from the US that has generally continued to surprise to the upside. As December has progressed, we have seen greater policy action from central banks to address immediate liquidity concerns in the European financial sector, including the introduction of longer term re-financing arrangements for maturing debt. In current investment parlance, this seems to have "kicked the can" a little further down the road buying time for policymakers, and while the cost of holding perceived safe haven assets remains at or close to record levels, the end of the year has seen volatility reducing as market reaction to economic data has become more sanguine. It is clear however that significant economic challenges do remain ahead in 2012.

The annual inflation rate in the UK has fallen slightly from its peak but currently remains substantially above the Bank of England target. The Bank itself now expects inflation to fall sharply in early 2012 as the impact of rising VAT, energy and import prices declines. This should alleviate any pressure to raise interest rates which we expect to remain at their current low levels into the medium term. The ECB policy rate was cut by new president Mario Draghi and is also expected to ease further as recession becomes a dominant concern in the Eurozone.

UK equities advanced through the quarter with the FTSE 100 finishing up over 8%. The strongest performance was seen amongst defensive large-cap companies with global reach as investors focused on solid dividend paying stocks. Performance has not been so strong in smaller caps and those companies more exposed to the domestic economy where unemployment remains high, consumer confidence depressed and growth is forecast to be flat into next year as the government continues to implement austerity measures, and recession in Europe impacts on external trade.

European equity markets staged a small recovery off a low base with the MSCI Europe index rising some 6% over the quarter. However, negotiations to address the Eurozone debt crisis continue and are currently dominated by Germany's insistence that much greater fiscal responsibility be imposed on peripheral nations, and that debt reduction be achieved through austerity rather than through fiscal transfer between Eurozone nations and improving the competitiveness of debt-laden nations. This strategy, coupled with uncertainty over the survival of the Eurozone in its current form, continues to pose a risk to any hopes for a sustainable European equity market recovery.

US equities saw the strongest rises in the quarter with the S&P 500 gaining over 11%. This gain meant that, notwithstanding the extreme turbulence and negativity in markets in the last six months, the index ended the year at exactly the same level as it started. Economic data, corporate earnings and business surveys through the quarter have raised the possibility that America may be embarking on a sustainable recovery as we head into a presidential election year, although the sustainability of growing US public debt remains a significant concern.

Japan was the only major developed market to fall in the period with the Nikkei 225 declining by just under 3% to its lowest year end close since 1982. The index has suffered a significant annual fall over a year in which the earthquake and tsunami in March, the declining outlook for global growth, and a strong yen, have impacted negatively on its industrial capacity and export led economy.

Emerging markets as measured by the MSCI Emerging Markets index saw a gain of over 4% in the period, although the performance of these markets has varied. The best gains were seen in Latin American markets, including Brazil, whilst Asian markets have lagged. India under-performed as it continues to fight inflation, while easing inflation in China has allowed monetary policy to be loosened in order to support moderating economic growth as China seeks to allay fears of a "hard landing".

Bond markets again saw a volatile quarter as sentiment veered between deep fear and cautious optimism in response to ongoing developments in the Eurozone debt crisis. Perceived safe haven assets such as UK gilts and US treasuries ended the period with yields continuing to sit at or near historic lows, while those countries at the centre of the Eurozone crisis, such as Italy and Spain, saw yields rising rapidly in November to exceed 7%, raising the spectre of sovereign default. Co-ordinated central bank intervention to add liquidity to the financial sector in December, and introdution of a re-financing programme by the ECB, did however lead to reducing volatility and saw riskier fixed income assets start to rally towards the year end.

Our comments below relate to our general approach to portfolios over the period. Actual activity on trading accounts may differ from this depending on personal circumstances, please refer to your Valuation and Transaction Statements for details.