Lind/Waldock Themes for 2010 Futures

The financial and commodity markets will be influenced by a number of major events in 2010. Central banks are ripe to exit a period of unprecedented monetary ease, governments in Japan, Europe, and the U.S. will issue historically high levels of debt, parts of the emerging world face real estate and equity market bubbles, and the U.S. will hold important midterm elections, which could impact consumer and business confidence. Furthermore, the euro will face a test of its reserve currency status with numerous countries failing to meet the Maastricht Treaty. These dynamics are occurring during a historically slow economic rebound. Below are ten themes which should influence market pricing throughout 2010.
1. Trend toward normalized monetary policy
As the international macro landscape continues to show signs of improvement, the unwinding of the ultra-stimulative policies that fueled the global recovery will be a major theme of 2010. Monetary tightening will remain very uneven as the continued variation in the pace of regional recoveries dictates a divergent exit. The draining of excess liquidity will expose vulnerabilities in the financial system.
2. Excessive appreciation in emerging market real estate and equity markets
Policy stimulus in the emerging world was excessive and likely exceeded the amount necessary. The policy backdrop remains supportive for EM equities. The cocktail of globally loose policy, the search for yield, and fundamentally appealing EM picture may prove to be a mixture quite alluring to capital, thus encouraging speculative flows.
3. Growing uncertainty over the ability of governments to fund large decifits
The IMF predicts that in 2010, the average government gross debt as a percentage of GDP for the seven major advanced economies will be 109 percent, and 113 percent in 2011. It was only 84 percent in 2007 and 77 percent in 2000. History suggests that post-recession, the reduction in government spending is rarely equivalent to the increase catalyzed by the retrenchment in the private sector. Diluted interest in government debt and an increased budget deficit-to-GDP ratio will put upward pressure on yields, and perpetuate steepness in the yield curve.
4. Jobless Recovery
A jobless recovery will characterize 2010. MFGR sees the unemployment rate peaking in 2010 at 10.5 percent and closing the year between 9.5 percent and 10 percent. The unemployment rates in EM and ASEAN countries should fall more steadily, while it will likely increase in Europe. On the U.S. front, the outlook for taxes is murky, and the healthcare initiative, which will likely force all employers to provide care or pay a penalty, will discourage the expansion of the labor force.
5. The composition of global growth in 2010 is not significantly different than 2009.
MFGR believes that the recovery pattern witnessed in 2009 will continue into 2010. Asia will see steady expansion. The U.S.’s economic outlook will pick up gradually and Europe will face a stagnant and anemic recovery. The U.S. will lead the recovery out of the Eurozone and Japan. Global imbalances will continue to unwind. Countries such as China will ultimately move toward tighter monetary polic and looser fiscal policy in terms of tax regimes in order to control inflation and perpetuate growth.
6. Passage of the Democratic healthcare plan will mark an apex in U.S. liberlism. Government policy will shift toward the center into mid-term elections.
The public is angry over the impact of a stimulus plan which may have saved the financial system from meltdown, but did little to improve the standards of living. Politicians, at the core, are survivalists, and thus, policy is likely to move toward the center to attract discontented voters.
7. The tax burden in the U.S. and Europe is likely to increase.
The ongoing deterioration in public finances, at both the state and government levels, will put upward pressure on taxes in the U.S. In Europe, taxes are increasing for higher-income workers in the U.K., and the Greek budget will work to cut down on tax evasion, while raising tax on property transactions.
8. The VIX is likely to remain capped.
Historically, the VIX moves inversely to the path of profit growth and positively correlates with the trend in the Fed funds rate, with a two-year lag. The trend in profit growth and the level of the Fed funds rate argue for low volatility through 2010. A major or lasting rally in capital market volatility looks more likely in 2011.
9. Investor appetite for commodity investment is uncertain, but most likely to ease.
Investment flows into commodities had been strong in recent years. The low interest rate environment and distrust of equity markets have supported commodity buying. Going into 2010, some of the headwinds supporting commodities as an asset class will diminish. It is hard to believe investors will year after year raise their allocations to commodities.
10. Intermarket correlations will erode as individual market fundamentals become the predominate driver of capital and commodity market price direction.
The heavy liquidation of all asset classes in late 2008 and early 2009 has ended, and money has moved back into the financial and commodity markets. The normalization of investment flow should allow markets to focus more on individual fundamental factors. Hot money is not likely to just flow in and out of the market based on risk-taking, as most books should be near desired weighting.