The past year has been pretty lacklustre for investors in the US equity market. After the euphoria of a second victory for George Bush and ensuing post-election rally, the market came down to earth with a bump in January and has been range-bound ever since.Equities have had to battle against several headwinds, including a spiralling oil price, rising inflation and subsequent pressure on consumers resulting from costlier motoring and heating expenses. Hurricanes Katrina, Rita and Wilma have caused record levels of devastation throughout the South-eastern states. Moreover, the Federal Reserve has maintained its commitment to monetary tightening, rais- ing interest rates at every meeting since June 2004. But there continue to be many reasons for investors to remain confident. The economy has proved remarkably resilient, GDP has risen by 3.5 per cent in the past year, the industrial sector has continued to expand strongly and the consumer sector, although experiencing a slowdown, has not buckled yet. The corporate sector remains robust, with free cashflow strong and corporations returning money to shareholders through buybacks and increased dividends. M&A activity returned to the market in 2005, with notable deals such as Procter & Gamble’s acquisition of Gillette and SBC’s acquisition of MCI. Earnings multiples have declined and the market has become much cheaper. While there may still be a few rate rises ahead of us, the first half of 2006 should see an end to monetary tightening. As the market anticipates the peak of the cycle, we expect P/E multiples will expand in a similar manner to the last sustained cycle of 1994-95. Cost pressures such as those from oil commodities should ease although the problem of the US budget deficit will remain. We expect the economy to continue to expand, with the corporate sector remaining robust, headline inflation receding and cost pressures (excluding food and energy) remaining benign. Although earnings growth will slow next year to a mid-single-digit pace, in 10 of the past 13 earnings slowdowns, the market has risen in the subsequent year, according to Lehman Brothers. This is in part because easing inflationary pressures increase the attractiveness of equities. As always, the US provides many interesting investment opportunities. We have tended to favour mid-caps over bigger companies and shunned stocks such as Wal-Mart in favour of smaller, nimble companies such as Advanced Auto Parts (a Halfords-type retailer), which is growing faster at a cheaper multiple. We believe the best value still lies within mid-caps, especially in the $5bn -$20bn market capitalisation range. Themes on which we are focusing include companies which are likely to generate increasing free cashflow, such as American Tower and wireless companies such as Sprint, beneficiaries of high levels of M&A activity, such as investment banks, and industries with pricing power, such as hotels and railroads. Over the past 12 months, the best-performing sector has been energy but comparisons have become more difficult and we are looking to become increasingly selective and reduce our holdings. The need to contain the budget deficit may become more urgent over the coming year and we are wary of companies that derive too much revenue from central government spending, including some of those in the healthcare and defence sectors.