Business changes by individual staples companies globally speak volumes for other businesses in indicating the potential for a prolonged quality oriented environment. Normality is likely further out into 2011. Risk premiums need to be watched even as LIBOR rates have dropped (such as for U.S. dollars to 0.43%), with junk bond yields down and despite low rate accommodative central banks. For market normality, greater transparency is likely to be as crucial now as after the depression and as Japan failed to pursue early after 1989. Distortions (including inflation behavior) took time to unwind from the global 1970s government deficit financing with at the other extreme, the failure of massive deficit financing to deliver from deflation in 1990s Japan- giving rise to vigilance bond premiums and heightened credit analysis. We see elevated volatility fixed income, with a neutral benchmark likely closer to 5% for 10 year U.S. Treasury T-Notes (currently 3.5%).At present equity levels (S&P 500: 980; MSCIWI: 1036) versus U.S. 10 year T-Notes, equity risk premiums appear close to 5% — under half the 12% spreads of the 1930s but close to the upper end of the 1970s-2000s. Market risk and rates indicate that equities are likely to be now sensitive to earnings recovery and rate trends. We favor, a quality overlay and also near term consolidation, our earnings recovery scenario notwithstanding.
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