Entering 2010, perception is that 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 market will face fresh real estate and equity market highs, and the U.S. will hold important midterm elections which will impact consumer and business confidence. The healthcare plan will mark a short-term apex in U.S. liberalism, followed by a government policy shift toward the center into midterm elections.
Asia (ex-Japan) will see steady expansion. The US’s economic outlook will pick-up gradually and Europe will face a stagnant and anemic recovery. Financial problems in the UK will hinder the macro landscape and the outlook for taxes will cause capital flight. In the Euro-Zone, structural problems and widespread violations of the Maastricht Treaty will enliven debate regarding possible failure of the Euro and test the Euro’s status as a reserve currency. Japan will face the hangover of a strong currency, growing debt, continued deflationary pressures and the internal political struggle over what strategy best fits the still newly governing Democratic Party of Japan.
None-the-less, as the international landscape gradually improves, the unwinding of ultra stimulative policies that fueled the global recovery will be a major theme of 2010. Monetary policy tightening will remain uneven as variation in the pace of regional recoveries dictates a divergent exit; for example, Australia and Norway have been the first to hike interest rates whereas the US Fed remains on hold. The draining of excess liquidity will expose the vulnerabilities in the financial system:
- The Fed will end their purchase of mortgage securities in March
- The Bank of England is set to reconsider their plan in February
- Europe’s covered bond program has successfully compressed spreads
The removal of these marginal buyers will expose the true cost of capital to the governments and could injure the recovery. If there is low interest in government debt and an increased budget deficit-to-GDP ratio, yields may increase and the yield curve will remain steep.
Strong appreciation in emerging market real estate and equity markets may need a period of consolidation. The policy backdrop remains supportive for EM equities. The cocktail of globally loose policy, the search for yield and a fundamentally appealing EM picture may encourage speculative flows. Additionally, if export demand remains low, then governments may be languid to respond to the building price pressures in fear of hindering recovery.
2010 will be characterized by a jobless recovery in the US and Europe. Unemployment will likely increase in Europe since many of the European stimulus programs were directed solely at hiring or preventing layoffs and are set to expire in the new year. As employers face a lack luster recovery, the likelihood of a robust expansion in the labor market sans government incentives is minimal. On the other hand, EM and Asian country unemployment rates should decline.
Intermarket correlations will erode as individual market fundamentals become the predominate driver of capital and commodities. The heavy liquidation of all asset classes in late 2008 and early 2009 has ended and money has moved back into the markets. The normalization of investment flow should allow markets to focus on individual fundamental factors. Trades will fixate on individual supply and demand stories with the highest return stories winning the most investment flow.
Michael Ashley Schulman, CFA
Hollencrest Capital Management