As The World Turns – Linkages Will Count

As the world turns, we expect linkages as returning to the fore over the binary behavior of most of 2009. As currency markets re-adjust in tier fashion in favor of the dollar against other majors, smaller and flexible currencies against most majors; and potentially emerging country currencies against the hitherto most liquid, political friction needs watching albeit assuaged by the U.S Treasury postponing its report on Renminbi/dollar exchange rates. Requiring a catalyst like Greece moving into crisis, the belated focus on sovereign risk is the first of more vigilante behavior. The size of advanced countries deficits with concomitant financing requirements on top of the magnitude of quantitative ease undertaken by central banks have prompted us to place them next in linkages of importance likely to push fixed income market rates higher even if administered rates are held artificially low. At the cusp of a new earnings reporting season, we see upcoming year-over-year quarter earnings momentum as large but slower than the last. We expect the interface of currency change and deficits to constrain valuation relative to higher government bond yield potential – such as the benchmark U.S. 10 year T-Note at 5%. In sum, we are skeptical of U.S. or global potential for valuation expansion as driver for equity markets as risk premiums in global bond markets are being re-established. A tiered approach to valuation as well as linkages on issues like credit risk and currency change underscore our call for a quality focus in markets overall, range bound risk for the first half from present equity levels and greater potential for gain later in 2010 as 2011 comes into focus; as well as for gold/precious metals as hedge.

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