Tuesday, December 22, 2009

>Global: Market themes in 2010 (DANSKE MARKETS)

• 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 uncertainty.

• 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 bonds.

• 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.

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 some point.

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.

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 bubbles.

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 the autumn.

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.

To read the full report: MARKET THEMES IN 2010