LOOKING back, 2009 was a year of bewildering but ultimately welcome contrasts. The year began amid fears that an unmanageable hole existed in the financial system and ended with the spectre of a self-reinforcing cycle of depression having receded.
However, the tide of recession has left behind a complicated tangle of budgetary problems, with National Debt levels rising at a pace normally associated with major wars.
There is growing interest in how (and when) central banks will be able to restore normal money market conditions and interest rates, and when governments will bring deficits under control.
The authorities are treading a delicate path between reassuring markets about their eventual intention to restore normal policy settings while keeping the oxygen flowing to a still somewhat breathless economy.
Markets have recently focused on the dollar as a potential economic weak spot. There is a prevailing assumption that US policy will remain looser than elsewhere, so investors are worried the dollar will continue to lose value.
Currency markets are notoriously difficult to forecast, with currencies only linked to economic fundamentals via long and stretchy elastic. However, the anti-dollar bias is hard to square with the forecast that the US will grow faster than other developed economies in 2010.
2010 is now very likely to see positive growth rates worldwide, after the sharp recession that bottomed in summer, 2009. The consensus expects developed economies to have lame recoveries, with debt reduction and fiscal policy acting as headwinds. On this view, investors should be more selective in cyclical investments, as 2010 shapes to be a year when companies will have to deliver on investors’ hopes.
Aside from the risk of a patchy recovery, the main risk is the uncertainty over how quickly central banks and governments will reverse their exceptional policy boost.
Policymakers have no road map for navigating out of the current position. There is likely to be a degree of trial and error, with a risk of policy being either too loose or too tight.
Good economic news may no longer be unambiguous good news for financial markets, owing to the risk of tighter liquidity. Ultimately, a sustained economic upswing would be better for equities than a market recovery driven by limitless liquidity, but the transition to an earnings-driven market may not be smooth.
The authorities, therefore, have a more complicated task in the coming year.
2010 will require them to avoid both inflationary and deflationary risks and decide how much austerity recovering economies will be able to bear, as a down-payment on returning the public finances to a sustainable footing. Strategically, the years ahead look likely to deliver better returns from “real” assets (such as property and equities) than cash or government bonds.
In a low growth world, there is likely to be a premium on the regions and companies that are the source of the best and most reliable growth. In 2010, what you buy (stock picking) may count for more than changes in index levels.
Companies that deliver should count for more than those that have risen purely on hopes of a cyclical recovery (which may disappoint in its pace).
Head of Research,