A Financial Year in Review - 2009

Good Morning Ladies & Gentlemen,

After 2008, 2009 was not going to get any worse, that was for certain.

But no-one - irrespective of industry - would have envisaged such a meteoric rise for global stockmarkets in the three last quarters of the year - Russia up 125.8% for the year, Sri Lanka up 125.2%, Argentina up 115% and Shenzhen up 111%.

The decade itself saw varied degrees of growth around the world and witnessed a few 'stumbling blocks' along the way (understatement of the decade it seems!).

This was pretty much a lost decade for the American stock market. But for much of developing world, it was the Roaring '00s - a period of soaring markets and breakneck investment that left even some bulls wondering if the good times can last.

While the broad American market lost about a fifth of its value in the last 10 years, emerging markets like Brazil, Russia, China and India powered ahead with gains in the double or even triple digits.

The numbers are staggering. On Ukraine's PFTS Stock Exchange - a Wild East of investing that did not even exist until 1997 - shares soared more than 1,350% over the last decade. In Peru, stocks jumped more than 660%. In India, the Sensex index leaped more than 240%.

To believers, those heady gains underscore profound shifts taking place in the global economy, where investment Dollars, Euros and yen whiz across borders and time zones with the stroke of a computer key. As many Americans wait for an economic recovery, money is pouring into the fast-growing economies of Asia and Latin America, as well as into oil-rich Russia and the former Soviet bloc.

It is easy to liken the economic rise of nations like Brazil, Russia, India and China - the so-called BRIC countries - to that of postwar Japan.

Amid all this euphoria, even some longtime bulls wonder if investors are getting a bit carried away. Emerging markets have a history of giddy booms and crushing busts dating back to the 19th century. They collapsed spectacularly in 1997, as a chain reaction of currency devaluations, bankruptcies and recessions rocked East Asia. In 1998, the Russian market plunged more than 80% after the country defaulted on its debts.

More recently, emerging markets tanked with the rest of the world in 2008, after shell-shocked money managers took cash from anywhere that seemed risky. But they were a bright spot in 2009 - the MSCI Emerging Markets index increased 73% in 2009, compared with a 25% jump in the S.& P. 500 index.

Despite 2009's gains, few predict a major setback today. Since the 1998 debacle, some developing countries have cleaned up their acts, balancing their budgets and improving their trade balances. As their economies grow, domestic investors have become big supporters of these countries' stock markets.

With interest rates low around the world, companies based in emerging markets, like their counterparts in the developed world, enjoy access to cheap money. High commodities prices have buoyed stock and bond markets in nations that are big exporters of commodities.

But the recent travails of Dubai, where a debt-driven bubble economy is now bursting, provide a powerful reminder that in up-and-coming economies, what goes up can come down - and fast.

That these markets have gained so much, so quickly - with some white-knuckled drops along the way - is exactly why I feel 2010 (towards the end of Q2 and Q3 in particular) is going to see some form of correction - it simply has to.

In the longer run, of course I see markets climbing but along the way, I can see corrections happening that could be as heavy as 25-30%.

Some market specialists worry that asset bubbles akin to the one that inflated and burst in the American housing market might be growing in places like China and Hong Kong. Others fret over the risks posed by volatile commodities prices, as well as over the inevitable end of this period of ultralow interest rates.

As long-term investments go, emerging markets seem to have a lot going for them. On average, developing countries have less sovereign, corporate and household debt than developed countries. Their economies are also growing faster than industrialized ones. Merrill Lynch predicts that emerging market economies will grow 6.3 percent next year, while the global economy expands by 4.4 percent.

Emerging markets are eclipsing their developed peers in other ways as well. Imports to the BRIC nations are likely to surpass imports to the United States for the first time ever in 2009, according to Morgan Stanley.

For the moment, the developing world is the engine of global growth. Emerging markets accounted for virtually all of the year's growth in global output, because developed economies shrank or were flat. Even if developed countries recover completely in 2010, emerging economies will account for 70 to 75% of the growth in global output for the foreseeable future.

Developing nations are also assuming a bigger role in the world economy. Morgan Stanley predicts that developing countries, including those in the Middle East, will account for 36% of total global gross domestic product in 2010, up from 21 percent in 1999.

All of this is a big lure to investors. Funds focused on equities in emerging markets attracted a record $75.4 billion this year, far surpassing their previous high of $54 billion in 2007, according to EPFR Global, which tracks fund flows.

Even after that influx, emerging markets still account for only a small fraction of investment portfolios in United States and Europe, the world's money management centres. Less than 3% of assets managed by United States fund managers are invested in emerging markets. That number could double in the next five years, some investment experts say.

Even normally conservative investors might be tempted to jump into emerging markets, given the sluggish outlook in the United States and Europe. After a dismal decade for the American/European stockmarkets in general, the developing countries might seem attractive.

The market is ending 2009 with some momentum. Since the lows in March, the major averages have gone up about 60%. For the year, the Standard & Poor's 500 is up more than 20%.

Besides the momentum, I think we will have another round of positive earnings surprises. So stock analysts will be adjusting their earnings estimates upwards, and money will continue to move away from the Dollar and into other assets such as the stock market - hence I view the recent Dollar's strength as not lasting much longer.

In fact, earnings will still outstrip estimates next year, as they did for much of 2009 - quite simply once again, if you set the expectations low, then nine times out of ten, companies will come in above the mark.

Next year I see companies ramping up their exports, thanks to a lower-valued Dollar, and Wall Street will race to buy stocks in those companies. So corrections apart along the way, stockmarkets next year should do rather well ..... unless interest rates start to rise!

This is where I see the middle third of the year being pivotal; the Fed and various other Central Banks cannot (and surely will not) keep interest rates as low for too much longer. When they do start to raise rates, that might help address a potential inflation problem but stockmarkets will then begin to give back some of their gains, especially in the second half of the year.

The stock market's roughly 60% rebound since this spring has been a much welcome and much needed reprieve from the financial carnage of the past few years.

However, this rally hasn't been a tide lifting all boats equally.

In large part, 2009's rebound has been primarily focused on lower-quality securities. It was these less stable companies which were beaten up the greatest in last fall's market plunge, giving them more room to climb back up this year. But at some point, market leadership is likely to shift away from lower-quality securities and toward a less-rewarded sector of the market.

A recent article in Investment News posed the theory that large-cap, blue-chip companies will be the next big winners as the market rally shifts into its next phase.

The idea is that investors have focused on riding lower-quality stocks as the economy has rebounded, but will soon shift into well-established, safer companies. If this shift does occur, well-recognized household names like IBM and Kraft Foods in the US are likely to be primary beneficiaries of this move.

Over the past decade, small-cap stocks have left their larger counterparts in the dust. While the small-cap focused Russell 2000 Index has posted an annualized 3.8% gain in the past 10 years, the S&P 500 Index has lost 0.6% per year in the same time frame. Big names certainly haven't been in favour in recent years, and are probably overdue for their day in the sun.

While smaller names ultimately have more room to grow over the long-run, market leadership does run in secular trends that can last several years. And odds are good that safe, stable, blue-chip companies are due to take the lead in the near future.

Even if market sentiment generally swings back in favour of higher-quality, large-cap names, there are still certain sectors of that market that have greater-than-average growth prospects.

One of the biggest corners of opportunity in the immediate future is likely to be health care. With a health-care bill getting closer to passage, prescription drug coverage for millions more of Americans could soon be a reality. That means big-name drug companies not just in America, but in Europe as well, could end up big winners as the volume of prescriptions filled picks up.

Another segment of the market that is hiding a lot of high-quality, big-name bargains is information technology. Tech spending was one of the first casualties of the current recession as companies cut back to save money. However, old equipment and computers will still need to be replaced.

As the economy picks up, there's likely to be a spurt of spending on technology as companies rush to upgrade and make purchases that they've been putting off for a few years. That means well-capitalized tech companies with dominant market share should be getting a boost.

Another positive sector for 2010 I feel, remains 'Agriculture' in particular and to a slightly lesser extent, Commodities in general.

For the Agricultural Sector, it is now costing more to get many of these out of the ground/off the trees than they are being sold for and this obviously cannot continue much longer.

Basic consumable commodities such as corn will do well as the standard of living rises in emerging markets and please remember of course, these are a hedge to a large extent against inflation.

For Commodities in general, I have read many articles that say there is a 'perfect storm' brewing for Commodities; absolute hogwash in my humble opinion and I see the opposite happening in the coming year.

There is heightened expectation from the commodity sector in terms of price performance and returns on investment. Widely anticipated economic recovery, especially in the OECD countries, and improvement in the market fundamentals of growth-related industrial commodities (especially crude, metals) encourage positive sentiment.

If I had to pick three 'medallists' in Commodities for the coming year, I'd pick Coal, Copper and Gold to all fly in 2010.

Gold? Yes, I remain totally bullish on Gold and the recent correction is in my opinion, short-lived and solely driven by the equally 'short-lived' rally in the US Dollar.

Gold for 2010; I see breaching $1600 as China, India, Russia, Brazil and even parts of the Middle East will continue to diversify their reserves away from over-reliance on the US Dollar as a store of value and within the next 2-3 years, surpassing $2000; you cannot get much more bullish than that.

This leads me nicely on to the US Dollar; "what's your view on the US Dollar"? has been the question most posed to me this year.

Let me start by looking at the US Dollar against Asian currencies first - this can go dramatically one of two ways (that's not fence-sitting, that is stating the two 'extreme' routes it could take).

Against the Aussie Dollar for example, the Aussie could reach parity with the US Dollar for the first time in 27 years in 2010, if Asia's hunger for Australia's commodities and assets deepens in the new year.

But after rising almost 32 US cents in 2009, the domestic currency juggernaut could be stopped dead if the US Federal Reserve lifts its target interest rate off historic lows.

The Australian currency is tipped to touch 96 US cents by June 2010 and will by December either take its best shot at parity or sink as low as 87 US cents a survey of top analysts shows.

The Australian Dollar's rapid rise in 2009 was in part due to Australia's high interest rate compared to its G20 trading partners. 2010 could see the interest rate gap close as other nations emerge from the global recession, with investors instead looking to emerging Asian markets to give the unit its "best shot at parity" by December.

Interest deferential has been very important throughout 2009, but for 2010 I think it's not just interest support but the nature of growth around the world which is shaping the fortunes for the Australian Dollar.

A central driver of the local unit's rise in the midst of the global recession has been Australia's overnight cash rate, which has been relatively high compared to other western nations.

Australia's inter-bank lending rate is currently at 3.75% and was at three per cent between April and September.

Meanwhile, the US Federal funds rate has been at a target range of zero to 0.25% since December 2008, while Britain and the European central banks all have interest rates at or below one per cent since early 2009.

While a US interest rate rise would increase investor demand for American-Dollar denominated assets, it is unlikely to happen in the short term.

But for me, that is a looming 'issue' in February that could mark the Dollar's 'card' for not just next year, but pretty much 2011 too.

In February next year, President Obama has to decide whether to renew the Bush Tax cuts or to let them expire. Let's see what will happen in either case:

If he lets the tax cuts expire, he will have lied to the US public by now imposing taxes on them which did not exist in for the past 10 years.

And while the spin doctors in the media will try to couch the fact by saying these tax cut roll backs will only affect the rich, I can assure you that everyone in the US will see the effects of such tax cuts in their annual tax bills.

If he does not let the tax cuts expire and renews them, he is ensuring that the deficits will rise as the tax revenues will not increase while the spending will continue.

The value of these tax cuts varies by different estimates. Some calculate the value of these tax cuts at about $980 Billion (Billion?). But that's before you count the interest on such cuts because the tax cuts were funded by deficits.

So conservatively, we can expect that the tax cuts cost the US Treasury about $1 Trillion over the past decade.

With the new health care reform bill going to cost about $1.1 Trillion over the next few years, we could see a rescue for the US Dollar if Obama lets the tax cuts expire. And if that happens, we will have direct confirmation that "by not raising taxes in any form," he didn't really mean the wealthy. In other words, he lied.

On other the other hand, if he renews the tax cuts, we will see another tidal wave of deficit spending that could send the Dollar in to a long-term tailspin.

That is what I feel is going to happen; to let those tax-cuts expire would mean President Obama taking over from Tiger Woods in the 'biggest flip' scandal and there is no way he is going to allow that to happen.

I see him renewing those tax cuts in February and the US Dollar slowly spiralling down for 2010 and all of 2011.

And what about China in 2010?

As 2009 draws to a close, investment bankers are focused on bonuses, league-table standings, and of course: what will happen next year. Similar to the rest of the economy, the biggest issue on many bankers' minds is China.

While the American and European economies stalled, and investments dropped, it is full steam ahead in China where construction continues to boom, and new metro centres are popping up seemingly every day.

Banks with teams in Hong Kong, or with branch offices in mainland China, are already reaping lucrative fees from Chinese companies purchasing everything from commodities to auto industries. But, this material financing is just part of the puzzle. The biggest piece of the bank opportunity in China remains in the investment banking field, underwriting. Dealing Yuan denominated stocks and bonds is a coup for any firm, though difficult to participate it - they can only be undertaken by ventures that are at least one-third Chinese owned.

While IPO's in Hong Kong often fetch 2.5% to 3.5% of fees on the value of the deal, IPO's in China's domestically listed shares can take month, with only a 1% to 2% fee value. But, just as in manufacturing, economies of scale dictate that it is a volume game.

Next year, Shanghai is set to surpass Hong Kong as the Number 1 market by funds raised, with as much as 380 billion Yuan ($55.7 Billion) in deals, as estimated by Ernst & Young. It is also expected that foreign companies will be allowed to list there next year, which will push this total much higher.

The Chinese government will deliver on its commitment to spend 1.18 trillion Yuan ($173 billion) before the end of 2010, the core of the country's stimulus package, a deputy finance minister said on Thursday.

The central government has pledged that amount out of its own pocket to support the overall 4 trillion Yuan stimulus programme, credited with helping the world's third-largest economy recover from the impact of global financial turmoil.

The promise not to pull back could serve to reassure markets hit by concerns over tightening in the property sector and worries that tougher lending practices could slow growth from the 8.9 percent annual pace in the third quarter.

Deputy Finance Minister Zhang Shaochun told reporters that actual spending in 2009 would slightly exceed the originally planned 487.5 billion Yuan, after it doled out 104 billion Yuan for the stimulus package in late 2008.

That could mean somewhat less than 588.5 billion Yuan gets spent next year, as originally earmarked, but the overall amount of spending from central coffers would remain the same, he said.

"There is no change regarding the 1.18 trillion Yuan government spending plan," Zhang told a news conference.

Beijing has said it would maintain its proactive fiscal policy and appropriately loose monetary policy stance in 2010, something Zhang reiterated.

The need to keep government investment at a high level was underlined by a government work group that oversees the stimulus spending.

"China is facing a very complicated situation in its economic development, with favourable and unfavourable impacts rising at the same time," the work group said in a statement given to reporters ahead of the news conference.

That assessment was echoed by Li Rongrong, head of the state-owned enterprises watchdog, who said in a speech that the economic recovery was not yet on solid ground.

"Investment and overall consumption are growing rapidly mainly because of policy factors, but consumer spending is still inadequate and exports have plunged because of a slump in international demand," Li said, according to a summary of his speech released by the agency.

Beijing is on track to achieve its budget targets this year, Zhang added. The central government has been aiming for a fiscal deficit of 950 billion Yuan, or roughly 3% of gross domestic product.

Mu Hong, deputy head of the National Development and Reform Commission (NDRC), the powerful planning agency, told reporters at the same news conference that the government would aim to keep this year's investment momentum in 2010.

Urban investment was up 32.1% in the first 11 months compared with a year earlier.

However, the desire to keep the economy humming has not stopped authorities from tweaking policy to make growth more sustainable.

In the latest such move, the central bank, banking regulator and other agencies issued a joint statement on Wednesday vowing to exercise stricter control over bank lending next year.

They outlined plans to guide credit to new energy projects and consumers, while choking off financing to polluters and sectors riddled by overcapacity.

Finally, what about the RMB in 2010? (Second most common question I have been asked this year).

In a lengthy interview with Xinhua, Chinese Premier Wen Jiabao made it pretty clear to the Chinese press that he wouldn't yield to international pressure for a Yuan revaluation.

China's doing fine as is, and is actually helping pull the world economy out of its slump. Thus China will simply adjust the Yuan when it's ready.

"We will not yield to any pressure of any form forcing us to appreciate. As I have told my foreign friends, on one hand, you are asking for the Renminbi to appreciate, and on the other hand, you are taking all kinds of protectionist measures," he said.

By keeping the Chinese Renminbi stable against the US Dollar, China was contributing to the recovery in the global economy, he said. "The purpose of these calls for appreciation is to hold back China's development," he added.

"A stable Chinese currency is good for the international community," Wen told Xinhua News Agency in an exclusive interview 27 December.

So reading between those lines (which is all that any of us can do), it does not look as if there is going to be any major change in China's 'Yuan Policy' anytime soon.

But as I have always said before, China has a propensity to slip in radical change when the rest of the world is looking elsewhere; which leads me nicely on to my final thought for 2010.

I actually feel that 2010 will see a major 'International Incident' force stockmarkets to correct ahead of actually when they WANT to correct.

It could be Iran and Israel; it could be a terrorist act at the World Cup; it could be Greece, Spain or Ireland going bankrupt and exiting the Euro.

I cannot shake the feeling that markets are not going to stop their bullishness and will continue their upward trajectory until forced to correct.

Let's face it, across the board global stockmarkets have risen incredibly fast and show no signs of stopping and I seriously believe it is likely to be a large-scale 'incident' that brings global financial markets back into the 'real world' - that 'real world' is most certainly not where they are positioned at as of me typing this today.

Penultimately for this Newsletter, I wanted to mention that I have not laboured over the annual global stockmarket charts this year as for three years running, not a single person has mentioned them being useful or found them interesting. So in order to keep things 'of interest' I decided to leave them out of the End of Year Review.

Finally, let's take a look at the closing figures for the major markets in 2009:

US Markets

How the US did this week .....

US Summary US stocks ended the year with buoyant momentum, but slightly down on the day in very light trading.

The S&P 500 spent less than 30 minutes in positive territory after the opening bell, eventually closing down 1 per cent at 1,115.10.

The US benchmark index has climbed 23.5% over the past 12 months: the biggest yearly gain since 2003.

The Dow ended near its intraday lows, down 120.46 points, or 1.1%, at 10428.05. The blue-chip measure ended 2009 with an 18.8% gain.

The Nasdaq Composite Index fell 1% to 2269.15, up 43.9% on the year. The Russell 2000 was down 1.3% to 625.39, up 25.2% on the year.