Sense & Sensibility & Risk:Avoiding Capital Misallocation

Despite twelve months of sharp rise in equities and reduction of risk premiums in junk debt, 2010 is still likely to be dramatic in the breadth of change. The sense and sensibility as well as risk of the markets, of companies and of the authorities now lie with avoiding capital misallocation. For perspective, we reflect on from 1988 (or just after the late 1987 global crash) to date, the Japanese versus the U.S. stock markets. Sclerosis before policy or corporate change risks growing chronic distortion, not just over the inflation or deflation purview of economists, but in the misallocation of capital – the purview of investors -. Such concerns are risks for markets notwithstanding likely ongoing recovery in earnings. Underscoring differential attempts to reduce distortions have been the rate increase in India as well as earlier in Australia and Norway, credit policy changes in China along with commentary by the Bank of Canada with more clarity needed from the Federal Reserve and the European Central Bank in particular.

Over 2008, even the Federal Reserve had cut- and- monitor rate positioning. Now, the reverse could equally apply to meter out distortion risk. Politically, 2010 going forward appears globally momentous. The European gap between Greece and Germany appears both about bearing funding costs and bridging the penchant in the north for sacrifice now for economic benefit later versus that in the south for enjoying now and letting the future take care of itself. In the United States, the passage of healthcare and imminence of financial reform have to be seen in the context of November elections and perceptions of America to come. Not least for China and India, in Asia the domestic political issue is that of inflation. We expect that range bound markets to prevail into mid year. In equity sectors, restructuring accomplished favors large cap energy as well as, alongside growth, information technology. We see U.S. healthcare reform as accentuating the advantages of restructuring as our long favored theme for healthcare.

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