Markets Aspire to Immaculate Transition; Reality Tougher

We see corrections as being an essential part of checks and balances that ascertain the robustness of assumptions being built into markets. In this context, equity markets (S&P 500 1,025; MSCIWI 1085) appear now to be anticipating earnings well into the second half of 2010. We maintain our valuation benchmark for the S&P 500 of 15-18x earnings with the latter being appropriate for earnings cycle low points (as likely occurred during mid 2009) but with the former being more likely as earnings proceed into normalization in late 2010 and through 2011.
 
Over September and October this year more than in most, markets likely need to critically assess political support for a wide ranged transition from expressions of principle to tangible benchmarks over a wide range of issues both for governments and for central banks due to linkages from deficits to trade to climate change to finance. Transparency on assets including standardizing credit derivatives in preparation for clearing houses akin to those for equities, moving liabilities onto balance sheets for financial institutions, capital reserve requirements tiered by risk of asset and lower leverage overall appear to us crucial financial issues. With numerous inter-linkages currently and fat tail alternatives at one extreme of rising inflation and at the other extreme, deflation due to liquidity trap, we continue to see gold bullion as a hedge. Separately, the mostly completed earnings reporting season revealed across industries continued duress over pricing of product/services.
 
The breadth of strategic global merger and acquisition activity from growth areas like communications and technology to cyclical areas like entertainment to even relatively stable areas like consumer staples all point to the challenge corporate managements envision in achieving revenue growth. Similarly, the large sized debt refinance and new equity issuance activities indicate the emphasis being placed on strengthening balance sheets. All these features for us favor quality, recent market behavior notwithstanding.

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