So far, in terms of the markets, 2010 has seen real volatility and a tale of two different types of environment. On the one hand, we have seen strong earnings growth, where corporates have continued to rebound following the massive monetary and fiscal stimuli in 2008 and 2009.

This has left many equity markets continuing to be relatively attractively valued on a longer term basis. On the other hand, there are now increasing concerns about the sustainability and durability of the global economic recovery in terms of employment and underlying economic growth.

After the recent setback caused by the debt crisis in Europe, company earnings have continued to hold up, with the result that many equity markets now look historically relatively cheap. We have also seen many companies that are very well financed, less reliant on bank funding and corporate debt funding, which have taken advantage of the weakness in many of their competitors' share prices to launch mergers and acquisitions (M&A) transactions. Clearly the strong companies are getting stronger in this environment with attractive opportunities for investors available.

We believe this strength is likely to underpin quite a few sectors of the equity markets because there is a clear evidence that this globalization of M&A is not only strong in developed markets, but is also, increasingly, international with emerging markets companies seeking to diversify into developed countries. They clearly see weaker share prices as an opportunity to build or gain market access for their products going forward.

The other side of the story, of course, has been the relatively good performance of bonds, particularly German, U.K. and U.S. bonds. During the second quarter of 2010, there has been a flight to quality out of the lower quality European Union (EU) bonds.

We now see interesting arbitrage opportunities between Greek, Spanish and Portuguese bonds, trading at over 200 basis points above German bonds. This development could be interpreted as a sign of weakness, or reflecting expectations that we may witness an eventual break up of the Eurozone.

Uncertainty has been the major cause of the flight to quality which we have seen recently, based partly upon the uncoordinated approach to dealing with the crisis by European governments, but also due to the lack of clarity on which European banks have exposure to which government debts, and the possible effect of a default by Greece, for example.

We have seen once again, as in 2008, that during weeks of great uncertainty and panic, the bond markets stopped trading. They become illiquid and therefore investors were left only with equities and the EUR as mechanisms to hedge for protection or to generate liquidity within their portfolios. Where investors have looked to hedge through the equity markets, this has reminded us of the Lehman and Bear Stearns crisis in 2008.

Let me try to give you an example of how equities can be affected by investors seeking to hedge risk. If an investor wants to hedge his or her Spanish exposure, the easiest way to do it, in terms of liquidity, would be to sell the Iberia Index 35 (IBEX 35); interestingly, two of the worst performers inside the IBEX 35 Index are Telefonica and Santander, which each represents some 25 per cent of the Spanish index1. Therefore, given that they are two of the strongest European telecoms and financial conglomerates in Europe, their share price performance clearly tells you more about the hedging that has gone on in the market than the fundamental prospects of how these two companies have been doing.

At RCM, we think some of this rather mechanical hedging and risk adjusting of portfolios have been providing quite a lot of investment opportunities - not on a short term or trading basis, but on a medium to long term basis. In the case of selected stocks, we believe that valuations stand at what we would call at "distressed" levels, given the fact that people are simply selling the future rather than looking at the valuation of the underlying investments - as illustrated by our previous example of Telefonica 1.

Moving on to the topic of the weakness in the EUR, many investors have seen the weak EUR as good for German exporters; we are now seeing that some of the German companies, such as Siemens for example, have outperformed many of their peripheral type competitors considerably in the last three months of 20101. As an investor, we prefer to focus on companies that are caught up in the distress of the market rather than simply investing in stocks purely because they could benefit from a weak EUR.

Finally, the recent flight to quality has, in our opinion, been accompanied by a certain level of deflation. But over a period of time, a weaker EUR is likely to lead to more expensive imports for Eurozone countries, which could in turn lead to a higher level of inflation in the future.

Interestingly, at the bottom of the TMT (technology, media and telecommunications) crash in 2003, the EUR was approximately USD0.85. When we talk about a weak EUR, we should prepare ourselves for a EUR that is no longer necessarily at USD1.20 but may be at parity to the USD. The economies within the Eurozone most in need of a weaker EUR are the Mediterranean EU members, which are not competitive at USD1.20 to the EUR, but could well be competitive at somewhere between USD0.85 and parity to the USD. Therefore, when looking to the future, we should possibly be expecting the EUR to head towards more of its internationally recognized purchasing power parity level of about USD1.05 to USD1.10. This is likely to cause concern for the European Central Bank (ECB) and the Bundesbank in the medium term and also for Germany, because it may well imply a higher level of inflation than Germany would like.

But the 'quid pro quo' for this is that it should help the peripheral countries in the Eurozone to gain a level of international competitiveness that they otherwise would be unable to attain with a strong EUR.

So to sum up, the weak EUR is supportive of many parts of the European corporate sector, helping to make Eurozone exports more competitive and help fill order books for 2010 and into 2011. However, it may well be a negative factor for Japanese or U.S. companies which find that they are now competing on thinner margins for the same business. This could lead to tension between different countries going forward, particularly if we see another downturn in the EUR towards more parity with the USD.

Looking at this from an equity perspective, the lesson we should be drawing from Greece is really two-fold. In finding a longer term solution to the debt crisis within Europe, both markets and investors need to see a credible plan being put together by European governments, to tackle both the immediate debt crisis as well as how the debt will be paid off in the future. Failure to do this will lead to continuing fears of a possible default.

At the moment, we see a somewhat complacent reaction from U.K. and the U.S. to the debt crisis in Europe. But we believe that this is a mistake, and that once the immediate problems in Europe fade, more attention may start to be focused on other countries which also have large fiscal deficits - which includes both the U.K. and the U.S.

The difficulty for politicians is that many of the banks which were nationalized following the crisis in 2008, are also holding significant amounts of government debts and related securities. So in the event of a possible default by a government within Europe, if there is effectively a 'fatal event', which leads to a re-pricing of risk (as we saw initially in Greece), then the organizations which are likely to suffer most in terms of losses, are European banks. It should be noted that, should European banks suffer major losses, the banks in U.K. and U.S. would also immediately suffer as well, as they are too closely interlinked and cannot take the counterparty risk of another bank failing.

In light of this, the aggressive policy response in the EU was, in our opinion, primarily to protect the banking system, which remains not only over-leveraged in terms of the size of outstanding debts, but in addition, is still hugely under capitalized.

Should the German government not have agreed to help financially support Greece and other Eurozone countries potentially at risk, then several German banks would have been directly at risk.

Looking at the source of the crisis in Greece, we estimate that Greece owes the rest of the world (including its own investors) approximately EUR300 billion. Based on our own calculations, we think that is approximately 50 per cent too high; the wider market at the moment is pricing the probability of a 25 per cent default rate by Greece in the future, which means that holders of that debt will lose substantial amounts of money.

In particular, the biggest losers would be the Greek banks, who are the largest owners of Greek debt. So for each country experiencing a debt crisis, any solution clearly needs to also find a solution for the banks within the country.

In terms of solving this crisis, the other challenge that Western governments have is that they are clearly borrowing money to finance what we believe in many countries to already be excessive levels of debt. Not only is there a limit to how much any one country can borrow, but once government debt gets to a certain level of gross domestic product (GDP), it is likely to forestall any type of longer term growth in the economy until that debt has been reduced and the ability to stop competing with private sector debt raising, i.e. the 'crowding out' phenomenon has diminished.

Given the sovereign debt crisis, we have to begin to differentiate between the types of stimulus. In the U.S., Japan, U.K. and in Europe, we are borrowing more money in the long term hope that we can recreate a self-sustaining level of economic growth. On the other hand, many emerging markets, in particular China, are spending money they have saved.

What is clearly evident is that the multiplier effect for restoring economic growth in the emerging markets solution clearly works. But in the developed world, we see increasingly that the more we borrow, the higher the future costs of repaying the debt are likely to be - a path which is not sustainable.

Finally, we should mention the fact that trade unions and employees across Europe are starting to demand a greater share of corporate profits - a trend rarely seen for the last 15-20 years. But the corporate sector, with increasingly strong balance sheets and high and increasing margins, are clear targets and can expect more such demands going forward.

Emerging markets, and in particular Brazil, Russia, India and China (BRIC), continue to show many of the longer term fundamental type of structural growth stories that you have heard about from RCM over the last two or three years. China continues to grow strongly overall, but at the same time is trying to cool possible overheating in cities such as Shenzhen, Shanghai and Beijing, focusing more on developing the rest of China. It is in the middle of a plan to try to rebalance China's growth and to spread the growth more evenly across poorer inland regions, instead of only coastal regions. Having spent an enormous amount of money to stimulate the Chinese economy, the Chinese government is still trying to keep domestic growth going, while trying to slow the faster economic growth in the coastal cities - but we should not expect this to detract from the longer term growth that we should see out of China going forward.

The question that springs to mind is why has the Chinese equity market performed so poorly? We have known for many months now that the big Chinese banks are due to be recapitalized after this lending boom and we are reading today about the Agricultural Bank wanting over USD30 billion worth of new equity from investors (1).

We believe that, to some extent, this has led people to sell the market this year and to wait for the funding to be completed before they come back to look at Chinese companies. We are starting to increase our exposure to China within our emerging market portfolios because we now believe that the market is looking much more attractive than it did earlier in 2010, in both relative and absolute terms.

When we look at India, we see a different picture - with stronger growth than we see in China, but which is accompanied by higher inflation. This is the usual type of economic growth that we are accustomed to, where strong economic growth leads companies to raise prices, which puts pressure on the central bank to put up interest rates - which is what is happening in India. What is interesting though, given that the rest of the world is growing so slowly, is that India is primarily driving its own economic growth through growing domestic demand - a very positive fact for the world's economy.

The best thing that has happened in the five or ten years since the phenomenon of the BRIC countries emerged as an investment theme is that they are all learning from each other what works and how to adapt this success to their own economies. Hopefully these countries will become an anchor that the rest of the world can rely on in the next three to five years.

In the rest of the world, austerity packages are likely to equal lower economic growth. Growth predictions in developed countries may turn out to be too optimistic within the current environment. Bondholders will therefore continue to monitor and be concerned about the financing and the affordability of countries' debts and future spending plans.

Looking forward to the rest of 2010 and into 2011, it is hard to see an aggressive step change in GDP growth anywhere outside the emerging markets. Whilst we have seen the tailwinds of the huge spending and fiscal stimuli of the EU, the U.K. and the U.S. in the first half of 2010, there is no doubt, month-on-month, that quite a lot of this will now fall away in the year-on-year numbers and so you will be looking at lower levels of economic activity if we have a double dip recession.

We believe the chances of a double dip are rising quite steeply at the moment. Should national governments begin to renew stimulus packages and borrow more debt to fund them, then the threat of inflation is likely to rise.

We expect national government to tackle their own macroeconomic and political challenges throughout 2010 - leading to an unpredictable environment for all investors. One recent example is Germany, which recently announced new measures to reduce the deficit, with a new austerity package. The new measures announced within the package targeted companies such as E.ON and RWE, both integrated energy companies in Europe, and also Lufthansa, which confirms our belief that governments will also look to tax companies more highly to raise more money (1).

We can expect to see these policies continuing for the rest of 2010, and also into 2011, as government seeks to tackle their deficits. As part of this activity, we may therefore see the privatization of many businesses which could raise the share of equity in parts of Europe, as utilities companies and motorway companies and other related government assets are privatized to try to pay off debt, much as the UK did in the 1980s with their privatization boom.

Note: 1 Stock references provided are for illustrative purposes only and should not be considered as a recommendation to purchase or sell any particular security or strategy.