Global: Market Themes in 2010
- In this article we highlight some of the main themes that will shape market developments in 2010.
In many ways 2010 is likely to be trickier as many issues will be less
straightforward than in 2009. Growth will look murkier and some of the
life support to the financial system will be turned off creating
- We recommend a slightly defensive stance with investment in high-quality equities and credit. Bond yields are expected to rise.
- Momentum in the business cycle will likely peak in Q1 and hence the tailwind to risky assets from cyclical momentum will fade.
- On the other hand, sustainability should prove itself with US job growth returning in early-2010.
The ECB is expected to hike before Fed and the gradual withdrawal of
liquidity will remove some of the support from low-quality sovereign
- The wall of money will still be around in 2010 but
not to the same extent as in 2009. Hence bond yields should rise. On
the other hand, with very low interest rates the search for yield will
continue and support high-quality credit.
- The extent of
losses in the banking sector is a highly uncertain factor and markets
may become more vulnerable to event risk when cyclical momentum fades.
Five themes that will shape 2010
#1: The peak of cyclical momentum.
#2: Sustainability of the recovery.
#3: Monetary policy exit.
#4: Wall of money and search for yield.
#5: Financial losses to be absorbed by banks.
Theme #1: Peak of the cyclical momentum
Risky assets generally thrive when growth is in the early - and
normally fastest - stages of recovery. As this year's brisk recovery
has happened alongside massive cost-cutting earnings have been in a
‘sweet spot'. However, much of the fuel driving the recovery is of a
temporary nature. The most important factor here is the inventory cycle
but fiscal stimulus and the boost to demand from Asian recovery will
also fade in 2010. Although we believe other engines will take over and
make the recovery sustainable (theme #2) growth is likely to peak at
We believe growth will peak in Q1 10 and that it will level off
during the remainder of the year. As the direction of growth is often
as important for confidence as the level of growth this means there
will be less support for equity markets - especially since equities
have reached fairer levels after the strong turnaround this year.
Central banks will also stay cautious as they see growth level off
again and it will put some limit to how many hikes the markets will be
able to price.
Theme #2: Sustainability of recovery
Sustainability will be at the core of developments in 2010. We are
currently in a positive feedback loop in which the global recovery has
raised confidence in financial markets. And with more companies joining
the recovery this is luring out more investment plans and denting the
massive job cuts. The next phase of the positive feedback loop is very
critical. We need to take the step from job cuts to job growth to bring
consumers back on a sustainable path to recovery. If private
consumption gets back on track it will unleash more investments in the
corporate sector and increase the need for rebuilding inventories. The
positive feedback loop continues.
As we have argued previously we believe there is enough fuel in
economic growth for job creation to get started (see for example
Research US - Job recovery ahead). So far employment data are on track
to reach our estimate of positive US payrolls in early-2010 and for it
to reach 200,000-250,000 in mid-2010 - especially after the latest job
report which showed a rapid decline in job losses in November to only
11,000. There are no indications yet that this recovery will be a
jobless recovery as was the case in 1992 and 2002. These jobless
recoveries were mainly due to new headwinds hitting the economy
(escalation of Savings and Loan crisis in 1992 and equity market
meltdown in 2002.)
Theme #3: Monetary policy exit
The pace of monetary policy exit will be important in 2010. Many
securities benefit strongly from the current life support - not least
in the low-rated sovereign bond space in Europe and CEE - and will
receive less support as the year passes. Liquidity measures will be
gradually phased out as already outlined by the ECB (see ECB - Heading
for the exit) and the Fed, but liquidity will remain ample during the
first half of 2010. When it comes to interest rate policy we believe
the ECB will hike rates in August followed by the Fed at the end of
2010. The ECB is expected to move first as the slack in the Euroland
economy is smaller and the ECB is more concerned about spurring new
Our view is somewhat in contrast with market pricing, which expects
both central banks to hike around September. Looking further ahead
market pricing of central bank hikes will likely rise as the job
markets recovery and hence lead to a rise in bond yields. But the
decline in growth momentum will put a ceiling on how many hikes the
markets will price. Looking into 2011 other contractionary forces from
the exit of fiscal stimulus and financial regulation will limit the
scope for rapid rate hikes.
Theme #4: Wall of money and search for yield
2009 has been characterised by a wall of money to be invested and
at the beginning of the year there were plenty of cheap assets where
the money could find a home. This has likely been a major factor behind
the strong rally in credit and equity markets, but it also explains why
the massive government supply has been absorbed so easily and - in
contrast to our expectations - led to a decline in bond yields during
So where does all this money come from? The answer is many
different places. While governments have increased debt levels, the
private sector has offered a large surplus of funds to be invested.
Deleveraging pressures have led to a strong rise in private savings and
very little private demand for corporate investment, financing of house
purchases, consumer durables, etc. On top of this central banks have
provided extra funds through their asset purchase programmes. With
Fed's purchase of USD1.25bn mortgage bonds it has more or less absorbed
all the need for funding in the US housing market. Banks have also been
a source of funding for governments as rising liquidity buffers have
provided demand for government bonds. Finally, Asian central banks have
been a source of liquidity in the bond markets as appreciation
pressures have led to more intervention and hence bond buying from the
Over the coming year, though, asset purchases from the central banks
will stop and we also expect deleveraging to slow somewhat as demand
for investment and housing is rising slowly. Finally, we do not expect
household savings ratios to rise further. Hence, although there will
still be plenty of money in the system it will be less than in 2009.
This will put some upward pressure on bond yields and also give less
support to risky assets.
That said, the still large amount of money that has to find a home will
probably mean that the "search for yield” will come back into fashion
and carry trades will dominate for some time, giving support to risky
assets in general - not least high-quality credit.
Theme #5: Financial losses to be absorbed by banks
As we saw in late-2009 event risk is far from over. Dubai and
Greece serve as prime examples. There is still large uncertainty over
the amount of losses that yet have to be absorbed by banks. Key areas
of uncertainty are: a) central and eastern Europe (CEE) loan losses;
and b) losses on commercial property loans in both the US and Europe.
These developments will be important for two reasons. First, it
will affect market stability. Too many negative events could shake
confidence and lead to a negative spiral in equity markets - with
negative spill over effects in the real economy. Second, it will affect
lending standards in the banks. The longer large losses loom the longer
it will take to get an easing of credit standards again.
It is very difficult to make a firm prediction of how this theme
will play out. In our base case we do not get new incidents the system
cannot handle, but it is an area of high uncertainty.
Other important themes
Other important factors include fiscal sustainability, the fiscal
exit, tightening of financial regulation and what happens to the US
dollar. There are plenty of uncertainties out there and 2010 is shaping
up to be another challenging and interesting year. Good luck!
We have moved close to our fair value target and anticipate
headwind to take over from tailwind when it comes to further uptrend.
We recommend investors to exploit a usual year-end rally to prepare for
a rollercoaster in 2010. This involves the following reallocation
shifts: a) Move into high quality; b) Move into high yield; c) Move out
of high beta; d) Reduce positions in Financials & Industrials. If
investors should buy stocks vs risk free assets in Q4 09, it should be:
a) Because investors are underweight in stocks; and/or b) Hold a
long-term horizon. Otherwise, further exposure to global and local
stock markets could be added at more attractive conditions than
Global: We recommend reducing exposure towards the
year-end. Position squaring keeps pushing short yields lower. Early
next year there is a risk of higher bond yields - in particular in the
short end of the US - as the year-end effects unwind. However, we need
more clear signals of tightening from central banks to get
substantially higher yields and flatter curves. Our medium-term view is
for higher yields on a sustainable recovery in the global economy, high
supply and the beginning of the phasing-out of central bank measures.
Intra-Euro: We still expect Spain, Greece and
Portugal to underperform and on longer maturities, we expect Germany,
Italy and the Netherlands to outperform in 2010. Scandinavian
government bonds are expected to outperform Euroland in 2010 given the
significantly better fundamentals.
Scandi: In 2010 we are overweight Danish callable
mortgages as well as capped floaters. We are underweight in Danish
government bonds and non-callables. We look for a flatter curve in
Norway and Sweden in 2010. We look for wider NOK swap spreads in 2010
and recommend longs in short-dated SEK mortgage bonds
Going into 2010 we remain constructive on credit. We believe the
key to outperformance is to be well positioned for the structural
trends in the credit market that have emerged as a consequence of the
financial crisis. Overall, we are currently overweight in investment
grade and underweight in high yield. Despite challenging fundamentals
for banks we believe that senior financials will outperform
non-financials as the balance between supply and demand is likely to
favour the former. General Industrials and Pulp & Paper spreads
have tightened significantly in 2009 and we expect flat or a negative
performance in these sectors going forward. We still believe that the
underlying credit positive fundamentals for the Nordic utilities are in
place but these themes are reflected in current valuations.
The recent dollar rebound looks excessive in our view and we expect
it to reverse in the new year. We expect ample liquidity, a still
dovish Fed, and risk appetite to take EUR/USD back above 1.50 in three
month's time. Further JPY gains should remain capped due to BoJ
intervention risks, and we expect EUR/JPY to resume its upward trend.
Sterling has received some support from the stronger USD and EUR/GBP
has dropped below 0.89.
Focus now shifts from common recovery factors to specific
fundamentals, such as capacity, demand and inventories for the
individual commodities. Oil has found strong support at USD70/ barrel -
we see risk skewed to the upside for oil from here.
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