Saxo Bank OUTLOOK 2011 Saxo Bank’s HQ in Copenhagen October 14, 2015.
SAXO Outlook 2010
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Transcript of SAXO Outlook 2010
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DaviD karsblDC, CHf CSDavid Karsbl has a masters degree in economics rom the University o Copen-
hagen, where he specialised in nance, statistics and monetary economics. His
masters thesis was about the pricing o gold since 1971. n 2009, David was
promoted Director and took over the C oce in the role o Chie conomist.
He started his career as an insurance analyst in ryg /S and joined Saxo Bank in
2003 as a macro strategist. n 2005, David joined the Strategy eam which he has
headed rom 2007. oday, he is responsible or the overall macroeconomic views
o Saxo Bank. David concentrates on Business Cycle nalysis and subscribes to the
reasoning o the so-called ustrian School o conomics (enger, Schumpeter,
von ises, von Hayek etc.). He believes that understanding debt cycles is integral
to understanding the general business cycle.
Christian tegllunD blaabjergCHf UY SSChristian egllund Blaabjerg has a broad educational background ranging rom a
master in Political Science rom University o arhus to a degree in nance rom
SB, arhus School o Business. Prior to joining Saxo Bank in 2007, Christian was
a quantitative analyst in Danish company ovozymes /S within sales and mar-
keting. oday, Christian works with equity market and single stock analysis using
a top-down approach by identiying the macro orces that will aect the invest-
ment environment beore they become obvious and then shit the ocus towards
individual issues within the sectors and single stocks. his approach determines
the extent to which stocks are subject to the critical variables, are positioned to
capitalize on them, and are attractively priced.
MaDs kOefOeDK SSads Koeoed has a masters degree in economics rom the University o Copen-
hagen, where his primary ocus was nance and econometrics. Prior to joining
Saxo Bank, ads worked or Danske Capital or two years. ads has been part
o the Strategy team since ay 2009 and his role is to concentrate on macr-
oeconomic topics and develop and maintain Saxo Banks macroeconomic models
based on econometrics. ads publishes comments and analysis on macroeco-
nomic topics and is responsible or the Banks macroeconomic models.
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rObin bagger-sjObaCkK SSobin Bagger-Sjoback has a B.Sc. in nternational Business and is a macroeconom-
ic analyst. His role includes supplying research notes and updates on various macr-
oeconomic topics and developments. obin joined the bank in ay 2009. n addi-
tion to distributing a variety o research notes on macroeconomic developments,
obin is partly responsible and a key contributor to Saxo Banks radingoor web-
site. Prior to joining Saxo Bank obin worked or gon Zehnder nternational.
jOhn j. harDyCSU fX SSriginally rom exas, John J. Hardy graduated rom University o exas at ustin
(graduated with high honors). He was head o Saxo Banks fX Strategy eam until
2008. oday, he works rom the US as a consulting fX strategist or Saxo Bank.
John has developed a broad ollowing rom his popular and oten quoted daily
forex arket Update column, received by Saxo Bank clients and partners, the
press and sales traders. John generates trading ideas to prot rom swings in the
market on a 1-5 day time horizon. He also writes regular ad-hoc commentaries
ocusing on the major currencies, central bank policies, macro-economic trends
and other developments.
niCk beeCrOftS fX CSUn Honours raduate rom xord University, ick Beecrot brings over 25 years
o international trading experience within the nancial industry, including senior
lobal arkets roles at Standard Chartered Bank, Deutsche Bank and Citibank.
ick was a member o the Bank o nglands foreign xchange Joint Standing
Committee. ick also contributes to contributor to Saxo Banks radingoor web-
site and relishes regular dialogue on the markets with clients at industry gather-
ings, such as awards dinners and conerences, at which he has in the past spoken.
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anDrew rObinsOnfX SSndrew obinson has close to 30 years o experience in the nancial markets and
worked in key nancial centers in ondon, urope and Singapore. He has been
stationed in sia or the past 15 years and joined Saxo Capital arkets in 2008.
He currently writes a daily market commentary or the sian fX trading session
and ormulates the fX trading ideas or Saxo banks Daily rading Stance. He also
contributes regularly to the Saxo Capital arkets blog and contributes articles
with an sia perspective to regional print media. ndrews fX strategies are based
on a combination o technical analysis, undamental analysis and market ow
inormation.
alan PlaugMannHD f fUUS & PSlan Plaugmann majored in nance at ondon University and is a native Danish
speaker and uent in nglish. He joined Saxo Bank in 2003 and is a specialist in all
traded utures: nterest ate and financial futures, quity ndex futures, Currency
futures and Commodity futures. Prior to joining Saxo Bank, lan spent 12 years
in ondon working at CB Corporation in the dvance rbitrage rading roup
and dvance rading roup with ocus on US & uropean bond arbitrage, market
making and proprietary trading.
Ole slOth hansen D f CfD & SD PDUCSle Sloth Hansen is a specialist in all traded futures, with over 20 years experience
both on the buy and sell side. le joined Saxo Bank in 2008 and is today Head
o the CfD and isted Products eam ocusing on a diversied range o products
rom xed income to commodities. He previously worked or 15 years in ondon,
most recently or a multi-asset futures and forex Hedge und, where he was in
charge o the trade execution team.
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C S
OutrageOus ClaiMs 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 7
2010 tOP10 PiCks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 9
reCaPPing Our 2009 POrtfOliO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 11
PreMises fOr yearly OutlOOk 2010: year Of reflatiOn . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .P. 12
H B PSPC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 12
fC KS 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 12
D CH S H: P D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 13
BU KS: S UD SSS 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 14
HUS 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 15
P S f DUB DP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 15
grOwth PersPeCtives fOr 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 17
US: SH S fS, BU SUS CHS . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 17
UZ: DS WH HD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 17
JP: DUB-DP H HZ S Df US . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 18
POliCy rates in 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 19
2010: breaking uP the OlD Patterns in fX? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 21
USD: S C UY S CY D SS S P . . . . . . . . . . . . . . . . . . . . . . . . . . P. 22
U: fD H DD f H D. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 22JPY: W H JPY CY D U? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 22
BP: H CS PCK? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 23
CHf: SB Y D WY BU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 23
UD: HH B CHS BUBB CK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 23
CD: S H SHUff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 24
ZD: CY DS K U . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 24
K: P B ZD? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 24
SK: B H U? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 24
tOP traDes fOr fX OPtiOns in 2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 26
equity OutlOOk 2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 27
investMent theMes fOr equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 32
energy in 2010: little eXCiteMent in stOre . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 36
COMMODity OutlOOk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 37
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Saxo Banks ten outrageous claims is a Black Swan
exercise prepared or investors every year. he banks
outrageous claims are an intellectual thought exercise
to help investors mentally stress test their portolios.
he chance that these claims turn out correct is no bet-
ter than 50-50. We usually get 2-4 right per year.
ast year, we were quite bearish, but the market has
since then turned around and we are now looking at a
year o reation and consolidation, which is reected
in the more balanced version o the utrageous Claims
or 2010.
bunDs yielDs tO reaCh 2.25%
(bunDs tO 133.3, Currently 122.6)
s a result o a combination o deationary orces
and excessive monetary policy, the yield on Bunds
and other sovereign xed income edges lower when
government xed income traders reuse to buy into the
growth story that is being told by the stock market.
ne or more negative, macroeconomic triggers could
orce the erman 10-Year overnment Bond to 133.3
by year-end in a general ight to quality. hat would
imply a yield o 2.25%.
viX tO 14 (Currently @ 22.32)
he X has been trending lower since late ctober
2008 and the markets assessment o risk more and
more resembles the one that characterized markets in
2005-2006 when trading ranges generally narrowed
and implied options volatility declined to completely
unrealistic and unsustainable levels. he market is
showing a tendency o exhibiting the same kind o
complacency towards risk, which could bring the X
down to 14.
Cny tO be DevalueD by 5% vs. usD
(nOw @ 6.8250)
he eorts o Chinese authorities to stem the credit
growth to avoid bad loans and the creation o bubbles
could ultimately reveal the Chinese investment-driven
growth as being decient. he massive, Chinese spare
capacity and an economic backdrop could be a decid-
ing actor in devaluing the CY vs. the USD.
gOlD falls tO $870 (Currently @ $1130)
general strengthening o the USD could break the
back o the speculative element in gold as o late.
lthough we are long-term bulls on gold (believing it
could reach $1,500 within 2014), this trade seems to
have become too easy and too widespread to pay out
in the shorter term. serious correction towards the
$870 level could shake out the speculative community
while keeping the metal in a longer-term uptrend.
usDjPy tO 110 (Currently @ 89.30)
lthough the downtrend in the USD is rooted in ir-
responsible scal and monetary policies, we believe
that the USD might snap back at some point in 2010,
because the USD carry trade has been too easy and
obvious or too long. t the same time, the JPY is not
reecting economic reality in Japan, which is struggling
rom a huge debt burden and an ageing population.
angry aMeriCan PubliC tO fOrM thirD Party
in the us
he many bail-outs and the general disapproval with
both o the big parties and the US political institutions
could propel a third and new party to become a decid-
ing actor in Congress ollowing the 2010 mid-term
elections. he US electoral system avours a two-party
political structure, but a demand or real change could
have large groups o the merican public orming
a new party as strong as oss Perots in 1992 ,even
though a vote or a third-party might mean wasting a
vote.
us sOCial seCurity trust funD tO gO bust
ctually, this is not really an outrageous claim. t is an
actuarial and mathematical certainty, but rom a civicperspective, it might be outrageous that the social
security taxes and contributions have been squandered
away or decades and that there is no money in the
trust und. 2010 will most likely be the rst year, where
outlays rom the non-existing trust und will have to be
nanced in part by the federal governments eneral
fund. n other words, the budget trick, in reality a
und without unds, will or the rst time in many
decades become observable on the federal govern-
ment budget. hus, part o social security outlays will
U U S C S 2 0 1 0
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have to he nanced by higher taxes, more borrowing
or more printing.
sugar tO DrOP One-thirD
(Currently @ $23.33)
he price o sugar has been supported by a combi-
nation o ndian drought and over-normal Brazilian
rain. he orward curve already indicates consider-
able downside beyond 2011, but we believe that a
normalization o the weather will make sugar one o
the less inspiring commodities in 2010. furthermore,
the high price o ethanol (a big demand or sugar) has
made both Brazil and the US lower the ethanol share
o gasoline by 5%-points. hat means lower demand
or sugar.
tse sMall inDeX tO rise by 50%
(Currently @ 888.88)
Small-cap companies have been underperorming the
ikkei lately, but their undamentals indicate a consid-
erably better investment case than their big-cap peers.
With a price/book ratio o only 0.77 and only about
12% o the index consisting o nancials, we know no
other index that is as cheap. t a continuation o the
recovery (at least positive DP gures) into 2010, this
index could very well surprise to the upside.
us traDe balanCe tO turn POsitive
ast time the US rade Balance was positive was briey
in 1975 ater a large drop in the USD in the atermath
o the oil crisis. he USD has become cheap enough to
stimulate US exports and punish imports and the trade
balance has already improved somewhat, but change
takes time and has momentum, so we will not rule out
that the trade balance could show a positive reading
or one or more months o 2010.
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1) shOrt eurtry anD Zartry
he Y is currently undervalued in our opinion. na-
tion pressures are building in urkey. Yields are way too
low at the moment, considering the improvements in
the economy observed o late. eanwhile the U and
Z are both overvalued in our opinion. Z is battling
with a looming atermath o the World Cup combined
with a weak public sector. he urozone has its own
problems, however, exemplied by reece and the
Club ed. Unemployment is bound to take o amidst
low growth and low yields.
2) lOng bunDs
We recommend a long position in Bunds as current
pricing seems too optimistic considering the diculties
that ermany and the urozone is still acing. We
expect low growth and ination in 2010 with numer-
ous sources o deationary pressures. he labour mar-
ket is still in distress and or the uro-zone as a whole
we see the unemployment rate above 10% in 2010.
his will put downward pressure on consumers will
and ability to spend. n addition, we like the sae haven
status that Bunds have whenever things get rough.
3) lOng Crb
he CB ndex has endured a torrid time since the
peak in mid-2008 even though several commodities
bounced back in strong ashion when risk appetite
returned. lobally we expect growth to return quite
satisactorily even though several heavyweights, Japan
and urozone included, will do their best to undermine
it. With global growth the demand or commodities
will continue to be strong, which will send the market
value north in especially the rst hal o the year.
4) lOng us10y anD shOrt jgb
We also avour the fX exposure that is inherent in
this trade. While both the US and Japan are expected
to struggle with weak to mediocre growth and high
unemployment in 2010, we argue this trade with
a simple question: Who wants to lend money to a
debt-burdened retirement-ready Japan in return or a
1.2%-1.3% yield? We also see potential in the US10Y
due to the deationary pressure that credit contraction
is inicting on the US economy (and the long period o
low fed rates that are the end result).
5) lOng tse sMall CaP anD shOrt nikkei
he small cap rms are undamentally undervalued
relative to their big sister, the ikkei index. While the
ikkei ndex has shot up roughly 45% rom the bot-
tom, the S Small Cap has only gained 20%. nd
this is despite the act the undamentals appear to be
better or small caps. he market is pricing in a 23%
discount to the book value (P/B o 0.77) even with low
exposure to nancials. With a weakening JPY, small
caps should do well.
6) lOng gwX anD shOrt nasDaq 100
he US stock indices are priced or a steep recovery
heading into 2010, but capital investments will stay
weak and thus the high P/ o asdaq is not justied.
elatively to the SD universe, the WX f o
companies in developed countries oers a more diverse
exposure to macroeconomic risks. fundamental valua-
tion is also at play here with a stable dividend yield and
low price/book. Coupled with the small cap potential
i growth resumes, we believe this trade has good
prospects relative to the asdaq ndex.
7) sell the MarCh 2011 sugar COntraCtSugar put on a strong display in 2009 as the price
was bid up due to weak supply stemming rom the
drought in ndia and heavy rains in Brazil. Production
is now improving and inventories will be rebuilt in two
years another bout o abnormal weather conditions
notwithstanding. With supply bound to expand prices
will come under pressure. oreover the ethanol share
o gasoline has been lowered by 5%-points in both the
US and Brazil, which is a direct hit to sugar demand.
8) lOng ishares s&P glObal energy seCtOrinDeX funD (first half Of the year)
We expect the sector to be a beneciary o the
global economic recovery and consequent rebound
in resource demand. he sector has recently begun
catching up to the move in oil prices, which we expect
to continue. he large integrated players (&P) which
account or the bulk o the sectors market cap have
lagged, and we believe a rotation towards this area will
lead to urther outperormance. n single stock level
we preer those companies with exposure to global de-
2 0 1 0 P 1 0 P C K S
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mand or energy, particularly those that are dedicated
to healthy dividend policies.
9) shOrt eurCaD strangle
he UCD is pivotal around 1.5500 and the break
even o 1.3900 and 1.7600 covers nearly all extremes
topside and downside in UCD in the last ve years.
furthermore, the low correlation to the USDJPY trade
we expect the USD to recover some lost ground
against the U in 2010 implies that USDCD should
improve and keep UCD balanced around 1.55-
1.56. ur recommendation is thereore: sell 1 year,
expiration8 Dec U Put, strike 1.4500, and, sell U
Call 1.6800, receive 590 CD pips, spot re 1.5600.
10) lOng DeC2010 3 MOnth shOrt sterling
futures COntraCt (leverage X20)
ong Dec2010 3-mth Short Sterling utures contracts,
currently 98.21, looking or unchanged rates and
99.40 at expiry. nitially place a stop loss at 97.80, and
trail it 40 ticks below the market. he British economy
is still in the doldrums and has been exceptionally
slow to improve compared to the rest o the global
economy. hus, the Bo might choose to keep rates
unchanged or an extended period like the fed.
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C P P U 2 0 0 9 P f
With nno Horribilis staring us squarely in the eyes we
constructed our portolio accordingly. With the world-
wide recession expected to continue and risk appetite
perceived to remain weak, we produced op 10 Picks
to reect these circumstances and in hindsight the
portolio was too negatively one-sided.
iven our chosen name or 2009 nno Horribilis,
the omnipresent insatiable lust or risk surprised us - to
say the least. Particularly the swit pricing in equities
or sharp -shaped recoveries in the US and uro-zone
was remarkable given the severity o the downturn.
nother surprise was the strength o the UD, which
came about courtesy o the enormous stimulus pro-
gram in China the worlds largest relative to DP.
China quickly managed to reate their asset bubble
and ustralia hasnt looked back since.
ur call or the S&P 500 in 500 unortunately did
not materialize what a rally that would have been.
nstead, two op Picks soured to such a degree that
overall portolio perormance was aected. Cobber
rallied steadily rom the pril bottom (return o 120%
in 2009) while our short position in the company aleo
could not survive the craving or risk.
he perormance o our portolio illustrates the hard
reality that the bounce back in risk appetite in 2009
was so overwhelming that pretty much every risky
asset was a keeper. With markets pricing in strong
growth in every corner o the world, the stage is set or
the economies to deliver.
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P S S f Y Y U K 2 0 1 0 : Y f f
2010 will be a year o reation just as the latter hal
o 2009 has been and the positive trends rom 2009
will continue well into 2010 as more sceptics will be
triggered to buy into the turnaround story ater
extraordinary amounts o stimulus to the developed
economies. ter the biggest YoY drop since 1938,
the S&P 500 in 2009 had the strongest hal-year rally
since 1933. he X went to 89.53 at the end o
ctober and has trended lower since then. n enor-
mous amount o reshly printed money has replaced
impaired assets as the federal eserves balance sheet
has exploded. his huge amount o new money is not
buying the stu that is measured in the consumer price
indices. t is rather being placed in nancial assets. So
that is where the ination shows up.
We were very bearish at the end o 2008, but our
bearish attitude only paid o until 9 arch, rom
where the stocks soared higher, triggered by the re-
laxation o the fSB rule 157 (mark to market), which
eectively allowed nancial institutions to at-out lie
about the value o their impaired assets. ur attitude
changed slowly rom outright negative to scepticism to
moderate bullishness to at bullishness in the secondhal o 2009.
ur bullishness is not grounded on the longer-term
sustainability o the stimuli that have been thrown at
the developed economies, but rather on the act that
they are likely to seem to work well into 2010 and
convince many investors on the sideline that the recov-
ery is real. ake no mistake, the current improvement
in nancial markets, in DP gures and consumer
sentiment is no more real than the speculative boom
ostered by easy money rom 2003-2006.
the big PersPeCtive
n our view, we have now entered the third o three
major credit-induced expansions since the mid-1990s.
he rst one (1994-2000) lasted seven years and was
based on deregulation and the reenspan put. he
second (2003-2007) lasted ve years and was primarily
driven by record-low interest rates and an unprec-
edented consumption binge. We entered the third one
by the second hal o 2009 and this one is not only os-
tered by low interest rates, but also quantitative easing
and a broad host o government bail-out programs.
he developed world has been dominated by credit-
induced bubbles since the mid-1990s (one could argue
or the past many decades) and every problem has
been met with lower rates and more debt. very time
DP was showing signs o contraction, central bank
rates were cut and consumers were willing to pile on
more debt to live beyond their means.
ow interest rates have ostered wild and irresponsible
speculation, over-investments and mal-investments.
We have now reached a point where spare capacity is
rampant in most industries and the debt burden is un-
serviceable, since income generation is stalling. n other
words, the too big a share o our disposable incomes
(both as households and nations) goes to service the
debt, which prohibits strong consumption growth.
What we need now is deleveraging and deaults in
order to reduce the debt burden and make it service-
able again. Unortunately, every government eort to
stimulate and support the economy to stand in
the way o this needed change on the path towards
long-term sustainability will only prolong the crisis and
lead to higher costs and lower trend growth.
finanCial Markets in 2010
financial markets have reacted quite positively to the
extraordinary stimulus in 2009 and we expect most
o the stimulating actors to continue well into 2010.
isky assets have risen the most (and dropped the most
in late 2008) and the markets have become a one-
bet street either you are long/in or you are short/
out. he only market that seems to be standing outis government treasuries, which in a recovery phase
like the one that is being priced into equities by now,
normally should have been losing considerable ground
due to higher ination expectations. n other words,
the government bonds market smells something shy.
verall, though, the market is currently displaying
record risk-willingness, but most indicators o nancial
health o stress are also ashing green as opposed to
their deep red colour in late 2008.
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ll leading indicators are roaring higher (although
one might argue that most are unduly ocused at the
growth o monetary aggregates) and it is thus very
unlikely to see weak growth the rst hal o 2010.
lthough growth is likely to be decent, monetary
policymakers will not be in a position where they eel
they can tighten monetary policy and the combination
o decent growth and extremely lax monetary policy
will be underpinning markets in the rst hal o 2010.
We expect the second hal o 2010 to be more chal-
lenging, since the market will begin to be materially
impacted by the wall o ption- and lt- resets
combined with more writedowns related to Commer-
cial eal state, beginning at the end o 2010.
n the rst hal o the year, we will likely see continu-
ously narrowing trading ranges and lower implied
volatilities in the options market. very dip is likely tobe bought and the market will look like it was 2005-
2006 again. isk-willingness is likely to stay strong or
a considerable time and it probably wont ade until
the second hal o 2010. lthough markets will be
(or are?) detached rom reality, investors will increas-
ingly ace the question: how can you reduce your
equity exposure, when DP growth is still positive? We
thereore expect market positioning to be quite bullish
towards the end o the year and the X to continu-
ously edge lower. hat will be signalling that we are
entering a high danger zone and most investors will
again be searching or the proverbial yield.
MegatrenD Change is here:
Private Deleveraging
he private sector (both households and businesses) is
now deleveraging or the rst time in many decades.
his is an important step towards re-establishing long-
term sustainability where demand is compatible with
the costs o servicing debt. he problem is that gov-
ernments are continuing to spend money in order to
stand in the way o deleveraging. he Japanese policy
response to the deating ikkei/Housing bubble rom
1990 has been catastrophically costly and inecient yet virtually all governments in the developed world
insist on pursuing the same, regrettable path. n a nor-
mal world, that would be crowding out private sector
initiatives, but this is not a normal world. t is a world
o hyper-credit creation and thereore, credit markets
seem to work quite well in an environment dominated
by record risk-willingness (so ar).
0
10
20
30
40
50
60
70
80
90
0
1
2
3
4
5
6
02-01-1990
VIX Index, RHS Credit Spread (Moodys BAA Rated Corporate Bond over 30-Year Government Bond Yield), LHS
02-01-1991
02-01-1992
02-01-1993
02-01-1994
02-01-1995
02-01-1996
02-01-1997
02-01-1998
02-01-1999
02-01-2000
02-01-2001
02-01-2002
02-01-2003
02-01-2004
02-01-2005
02-01-2006
02-01-2007
02-01-2008
02-01-2009
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We expect the private sector deleveraging to continue
in the next decade due to high(er) unemployment,
excessive spare capacity in most industries and continu-
ously dicult access to credit. his will result in disina-tionary/deationary pressures in especially the coming
three years. he headline CP deation seen in 2009
has largely been a result o the YoY eect o collapsing
energy prices in the second hal o 2008. Core ination
has moderated somewhat over the year, but we expect
more o a attening in 2010. s a side-eect rom
more savings activities, the US current account decit
will shrink considerably. sian and countries have
demonstrated a clear reluctance to keep more USD
denominated assets, but US households and banks
are more than able to replace the lack o buying romoreigners. he historical holdings o treasuries in US
households and banks have been signicantly higher.
he same goes or balance sheets o households and
banks in the urozone. combination o higher sav-
ings and a larger allocation o government securities in
household and bank balances will thus help keep the
yield curve at in 2010.
he change in international capital ows is another
megatrend reversal. t is an economic perversity that
poor, high-growth countries have been nancing
rich, low-growth countries or the past decade. his is
changing and the consumers in the developed world
will have to tighten their belts. fiteen o the most in-
debted countries account or 47% o global consumerexpenditure in 2009. n other words, rapid consump-
tion growth in the developed world will not be a viable
path in the coming years. merging markets will have
to rely more on domestic consumption, and capital will
to a larger degree support the currencies, which
will appreciate vs. all the most liquid currencies.
labOur Markets: still unDer stress in 2010
abour markets will continue to be under consider-
able stress in all o 2010. ooking at the US, there is
a strong, positive correlation between manuacturingcapacity utilisation and onarm Payrolls (fP). n
average, fP only turns positive i capacity utilisa-
tion creeps above 77. t is currently around 71 and
even in recoveries, it rarely increases by more than 2
points per year. he current crisis might be dierent
in severity and the recovery might thereore have a
sharper -orm, so we will allow an assumption o a
3 points growth per year. ven with that assumption,
fP should not be positive on average until 2012. n
top o that, fP actually needs to be above 200K per
month in order to ollow the population growth. We
0,7
0,9
1,1
1,3
1,5
1,7
1,9
Bank Lending Declining Despite Extreme Stimulus (Index 2002)
Japan Loans & Discounts Otstanding
01-05-2000
01-09-2000
01-01-2001
01-05-2001
01-09-2001
01-01-2002
01-05-2002
01-09-2002
01-01-2003
01-05-2003
01-09-2003
01-01-2004
01-05-2004
01-09-2004
01-01-2005
01-05-2005
01-09-2005
01-01-2006
01-05-2006
01-09-2006
01-01-2007
01-05-2007
01-09-2007
01-01-2008
01-05-2008
01-09-2008
01-01-2009
01-05-2009
01-09-2009
US Bank Credit Outstanding
Euro Area Loans to Non-Financial Sector Outstanding
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thereore expect the unemployment rate to continue
increasing but at a slower pace until 4 where it
will most likely stabilize around 10.7%.
ooking at Western urope, the labour market typically
lags the US by around a year. hat means that the
urozone unemployment rate will rise rom the current
9.8% to around 10.2% in 4. for Japan, we expect
the unemployment to rise as well, but only to 5.2%.
abour markets in most o the developed world are
under severe stress due to labour arbitrage. he current
economic crisis serves as an excuse to reduce costs by
slashing expensive labour and outsource production
to low-cost countries in astern urope or South ast
sia. hereore, labour markets in the US and Western
urope will not exhibit upward wage pressures in the
coming years.
hOusing in 2010
Housing markets globally are not only beginning to
stabilize. Some are showing unettered bubble-like
expansion again. ost noteworthy is orway, which
barely noted the international crisis in housing. or-wegian homes are now making all-time highs. Similar
thoughts are probably on the minds o the ustralian
central bankers that have hiked interest rates by 75
bps. so ar in the last hal year. n the other extreme
the US housing market is still under considerable pres-
sure due to years o extremely lax and irresponsible
lending standards. While in most countries, the low-
end segment o housing is stabilizing because o low
interest rates and increased aordability, we still see
an additional downside o 5-10% or US housing. he
mid-to high-end o housing might drop even urtherin the US due to oversupply and distressed sales. n
other words, housing is still an overall drag on the
perormance o the US economy and we dont expect
residential construction to contribute signicantly to
any recovery in the US. ending standards have been
less irresponsible in the urozone, so we only expect a
downside o 5% in general.
POtential triggers fOr a DOuble DiP
he sub-prime problem is about to be actored in,
since most sub-prime mortgages have been reset ater
the two-year teaser rate periods. here is no doubt,
that sub-prime mortgages have caused substantial
problems on the balance sheets o nancial institu-
tions. However, the wave o resets is now over and
most problems related to sub-prime now seem to be
dealt with. Unortunately, another big problem is on
the way in terms o resets o the Opo-arM d
a-a (a combined $3 trillion o debt outstanding)
that were primarily taken out by the mid- to high-end
(H) segment in US housing. ption-s typically
had a ve-year reset period rather than the two-years
in sub-prime and at the same time, the H segment
has typically been lagging the low-end segment in the
downturn rom 2007. 2009 and most o 2010 are thus
characterized by a sweet-spot valley between reset o
sub-prime and option-s. he negative dynamics
o the sub-prime resets will be even more erocious
or the ption s, since they represent a big-
ger market and happen when the owners have even
lower or negative home equity. aken together, ption
s and lt- resets will rom the end o 2010 and
onwards drain hundreds o billions o dollars rom US
home owners that are in many cases unemployed or
in other ways unable to pay on the high oan-o-alue
mortgages. t the end o 2009 we estimate that only
$500 billion o outstanding mortgage debt will have
been reset to market rates rom teaser rates. ver the
coming three years, this amount will triple. hat means
that the number o so-called strategic deaults will
continue to increase as any social stigma related to
deault will gradually ade away as more and more
mericans hand in the keys to the bank (in the so-
called non-recourse states).
nother major problem stemming rom US structurednance is the Commc r e (Cre) (about
$3.5 trillion outstanding), which is awaiting a colossal
need or renancing in the coming years. C delin-
quency rates have exploded but seemed to peak in
ovember. We estimate that 3%-5% o outstanding
C debt is likely to deault and losses will be horriy-
ing, since the collateral has deteriorated signicantly
since the most problematic C vintages (2005-2007)
were issued. ost vintages had a ve-year renance
built into the deals and these are now showing up in
the calendar, especially 2010-2013. So also on this
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note, nancial institutions will most likely ace huge
losses or a need to allow maturity extensions (like in
the HY corporate bonds market), but this will put their
liquidity provisions under pressure and probably orce
policy makers to extend P a third time.
ne o the biggest and most inuential, potential trig-
gers in 2010 could be a sharp decline in economic ac-
tivity in C. China has ocially been able to main-
tain an impressive growth throughout 2009, but in our
opinion, the quality o the growth has been extremely
poor and we strongly doubt that they have had real
growth during all o the year. Data on Chinese electric-
ity use show a marked decline in the rst hal o the
year and the Chinese national accounting seems to us
to be highly contradictory. ots o anecdotes about the
inconsistency o car sales and gasoline consumption,
empty skyscrapers etc. contribute to our scepticism on
China. ur overall view on China is a mix o shock and
awe and scepticism. here is no doubt that a mix o
strong work ethics and a very high investment-to-DP
ratio have been underpinning strong growth or years.
But on the other hand, the Chinese economy is mixed
and thereore doesnt allocate its capital eciently. Weear that the so-called investment-driven export model
or China has run into a brick wall o ading, Western
demand. Chinese exports are down almost 20% over
the last year and Chinese overcapacity is rampant in
especially metal manuacturing, concrete etc. Chinese
authorities are now considering how to reduce lending
growth in order to avoid bubbles and bad loans. We
say that it is too late and that will become apparent
in 2010 or 2011. he eyes o the world are looking at
China in the same way as they did on Japan in 1988.
nother potential trigger or market turmoil could be
urther unravelling o D debt. We have been o
the opinion that the problems in Dubai would and will
be a non-event to global, nancial markets or two rea-
sons. first, the Dubai DP (about $65 billion) is quite
modest in an international comparison and second, we
hold a great deal o sympathy or the small emirate.
lthough the property boom was unsustainable, the
political structure (and tax system) o the country will
provide support or uture growth and enable it to
attract business rom not only the region, but rom the
whole world. onetheless, a number o UK banks hold
a large exposure to Dubai, but we dont expect it to
have material impact on markets in 2010.
gc, on the other hand, is in danger o a deation-
ary debt spiral like the one that reland has experienced
in 2009. nation is still positive (and actually rising to-
wards year-end), but huge budget and current account
decits will be a real challenge or both reece itsel
and the uropean Union as a whole. llowing reece
to continuously violate the aastricht criteria (budget
decit to stay below 3% o DP) would enorce moral
hazard and ree riding. he U will suer rom the
dramatic tensions within the U and the imbalances
in the PS countries will provide an additional reason
to expect the U to underperorm in the longer run.
Unlike reland, reece has so ar not been showing a
political will to solve the problems. n the contrary,
reece has allowed them to grow or too long. reece
is a real problem or the U, or the U and or U
in 2010.
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us 2009q4 2010q1 2010q2 2010q3 2010q4 2010
DP (o, S) 3.2% 3.0% 2.3% 0.5% 1.6% 2.2%
PC (o, S) 3.2% 2.1% 2.1% 1.5% 1.8% 2.1%
CP (YoY) 2.5% 2.1% 1.7% 1.5% 1.2% 1.6%
Core CP (YoY) 1.8% 1.7% 1.6% 1.7% 1.7% 1.7%
Unemployment ate 10.1% 10.3% 10.4% 10.6% 10.7% 10.5%
us: sMOOth sailing at first, but seriOus
Challenges reMain
he economy is picking up speed in the US, but how
much o the recovery is dependent on a US reasury on
overdrive? uch, we believe. ur main scenario is or
weak growth in 2010, though not a double-dip. How-
ever, not much must go wrong beore the prospects o
a double-dip increase.
he economy has rebounded somewhat in 3 (and
most probably 4) o 2009. his will be carried over
into 2010, supported by continued government
spending, private investment, and stimulus-induced
private consumption. he private consumer has been
aided in the second hal o 2009 by various stimulus
programmes. uch o this stimulus is peaking now in
terms o the percentage eect and will soon begin to
level o. Consumption will reect this in 2010 as con-
sumers will increasingly need to end or themselves.
But or them to be able to consume, incomes must rise
suciently; a daunting prospect with unemployment
expected to remain above 10% throughout the year.
Private investment will also continue to contribute
positively to the economy in 2010 as inventories are
now so low relative to sales that some rebuilding is
needed. Business inventories are to have nally reached
a bottom, and the strength o DP in 2010 is largely
dependent on the amount o inventory rebuilding
necessary. We do not expect a return to pre-crisis
inventory-to-sales levels, but less will do. dd to this
the act that residential construction ell o a cli in
2006 and is only now bottoming out or an annualized
decline o roughly 27%, and you have plenty o room
or an increase in private investment.
We target DP growth o 2.2% in 2010, but recognise
that there are several risks to our orecast scenario.
mong them a C collapse, residential mortgage
resets, and a continued credit squeeze in small busi-
nesses are the most threatening.
eurOZOne: MODest grOwth aheaD
he urozone exited the recession in 2009 3 carried
along by recoveries in ermany and france. But while
the urozone is no longer in recession, we oresee a
tough year with weak growth o 1.4%. he region
aces plenty o challenges, but private consumption
worries us the most.
ll over the urozone, consumer spending aces head-
winds rom weak labour markets. Companies continue
to lay-o workers and we expect this to result in an
unemployment rate o 10.3% some time in 2010 3,
which will curb private spending. he modest spending
by consumers will eed back to companies, which in
turn will take longer to bring the number o unem-
ployed down. ts a dicult cycle to break, not least
when ones currency is quite strong against major trade
partners.
he recovery in manuacturing is exhibiting signs o the
sought-ater -shape, conrmed by recent surveys. But
as in the US, the service sector is acing stronger head-
W H P S P C S f 2 0 1 0
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P C Y S 2 0 1 0
us MOnetary POliCy
n 4 ovember, the fC reerred specically
reerred to low rates o resource utilisation, subdued
ination trends, and stable ination expectations, as
the economic rationale or keeping rates exceptionally
low or an extended period.
Capacity utilisation is at 70.7% extremely low in
historic terms we have to go back to 1982 to see
anything remotely similar. Home vacancy rates are still
historically high; once again the story in the residential
property market is o a market just turning the corner,
but how strongly and how durably? Watch out or
uture headwinds, such as the continuing massive
overhang o oreclosures and resets o ption-s
with ve-year negative amortization resets, which will
start to haunt the mid- to high-end segment.
We orecast quite subdued (core) CP throughout
2010. Why? he combination o severe underutilisa-
tion o resources outlined above and a monetary policy
constrained by the zero-bound, represents a potentially
lethal cocktail, such that we should worry more about
a damaging period o deation, rather than ination.
lthough the Japanese lost-decade experience is by
no means an exact analogy, and the US policy response
has been much more aggressive, there are worrying
similarities. rguably, the US economy was character-
ized by greater imbalances at the height o the bub-
ble with the greatest single problem being that debt-
uelled consumption topped 70% o DP meaning
that the output gap in the US economy is much larger
than Japan ever aced.
he study o just how the public at large ormulate in-
ation expectations is a somewhat opaque science, but
economists suggest that there is a tendency to orm
ination expectations somewhat irrationally, involving a
high degree o regard to recent, historical experiences.
so, then the events o the last year or so, with rapidly
alling headline CP, could lead to a damaging negative
eedback loop, leading expectations to begin to decline
once more.
ll in all, and having due regard to what the fed is ac-
tually telling us, (please also note how on 7 December,
the very rst business day ater release o the ovem-
ber employment report, when market rates blipped
up, Chairman Bernanke raced to reiterate the mantra
about keeping rates low or an extended period),
it seems highly unlikely to us that the fed would risk
derailing the nascent and ragile, (Bernankes word), re-
covery. his is especially true given the declining stimu-
lus that will be orthcoming rom already enacted scal
measures in 2010 and also the orthcoming natural
diminution in size o the feds unconventional monetary
stimulus measures, to which we alluded above.
t fd fd r od m cd
oo 2010 d o Opo-arM,
a-a d c o Cre m oc
fd o co tarP mo
2010.
eurOZOne MOnetary POliCy
s our orecasts suggest, we see 2010 as a year o
steady but modest recovery, with headwinds including
rising unemployment and subdued consumer spend-
ing and ination. gainst this, manuacturing seems
to be in much better shape, with inventory restocking
continuing, and P surveys have also turned or the
positive in many o the larger countries. Whilst there
are undoubtedly large variations in the scal health o
various member states (especially the PS countries),
the ortunes o the relatively smaller economies should
not be enough to derail recovery in the zone as a
whole.
he strength o the uro poses a particular challengeor especially Southern uropean exports. he risk
remains, however, that UUSD could go well into the
1.50s due to a continuation o the USD bear trend. he
CB would probably delay any rise in their ocial rates
in the ace o a much stronger uro. n 3 December,
the CB announced that the last 1-year liquidity repo
would take place this month, with the rate to be
variable-indexed to the minimum bid rate at the regu-
lar s, and the last six-month operation will take
place in pril 2010. richet underscored several times
that the change shouldnt be seen as having any eect
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on the uture trajectory o rates. uribor utures out
to June 2010 are almost back to their all-time highs,
implying rates at all-time lows.
O c co od o cd
, q4, d mc-
ocoomc dcp, po comd
o eo- o pc;
xc d o ,
c od c 10%-20%
cc o ocom.
jaPanese MOnetary POliCy
Japan aces almost insurmountable challenges: weak
growth, strong JPY, deation, leading to rising real
interest rates and scal irresponsibility. lthough the
situation is improving slightly in 2010, the balance
sheet o Japan is still in a dire situation.
n the absence o urther BJ action, the danger
remains o continued appreciation o the yen with
ndaka, the Japanese word or the strong yen, becom-
ing an acute problem, due to the possible emergence
o a so-called one-way bet as ar as the market isconcerned.
n light o this, we should expect to see a pot pourri
o urther measures rom the BJ, over the coming
weeks and months, possibly including a reduction o
poc oo om 0.1% o 0.05%,
o commm o p
o, o xdd pod, o
d/o o commm o co
qe co CPi d d o zo. f-
mo, m oo jgb pc co.
uniteD kingDOM MOnetary POliCy
n many ways the UK economy aces exactly the same
challenges as the US to a greater or lesser extent; an
over-leveraged populace trying to shirk-o an exces-
sive consumption habit, hitherto uelled by cheap
credit, high unemployment, a housing market in pain,
displaying a short-term stabilisation, a large output
gap, no oreseeable ination problem, but massively
over-stretched public nances.
ll-in-all a recipe or continued monetary stimulus,
especially in light o both main political parties avowed
intent to return the country to a degree o scal
probity-indeed we have witnessed the bizarre sight o
the two parties engaging in a desperate bid to appear
the more prudent in the run-up to the orthcoming
election, which must be held beore 3 June 2010, and
which looks increasingly likely to be on 6 ay.
t would seem unlikely that the Bank o ngland would
choose to ramp up its asset purchase programme
again, (), having put it on a reducing glide path o
25bn over the next quarter, as opposed to the previ-
ous rate o 25bn per month.
Oc , c m p od d-
c . Dp c m c
o b o oc o o d
o, goo k co o m
o do m o
coom popc o 2010, -
c c , d MPC, cd.
ucd oo 2010 od oc oc.
tOP traDes fOr 2010 in interest rates
ong 3-mth Dec 2010 urodollar contracts, (DZ0),
to express the view that the fD stays on hold longer
than the market thinks, currently 98.78, target 99.70-
75 at expiry. he stop loss has to be as ar away as
98.40, and then trailing- 40 ticks below the market i
the price rises- as there will be hiccups, as caused by
last weeks non-arm payroll release.
Purchase June 2010 uribor contract, (0), 99.25
calls or 3.5 ticks. You should at least break-even i
CB rates havent moved up by then - and this trade
gives you a very cheap option to capture the chance
the CB has to cut rates to curb massive uro strength.
ong Dec 10 3-mth Short Sterling utures contracts,
currently 98.21, looking or unchanged rates and
99.40 at expiry. nitially place a stop loss at 97.80, and
trail it 40 ticks below the market, as with USD utures,
above.
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he fX market in 2009 was dominated by the axis
o risk appetite and the emergence o the USD carry
trade. 2010 is a new year, however, and we suspect
that, just as ew analysts got 2009 right, 2010 could
oer plenty o the unexpected or currency investors
and traders.
2009: the DraMatiC return frOM the brink
2009 began with another enormous downdrat in risk
appetite that ollowed on the previous alls global
deleveraging catastrophe. he nadir or risk appetite
was ound already in early arch, and rom there asset
markets staged an enormous, almost uninterrupted
climb into the end o the year. he low yielding USD,
which had gained as a sae haven during the turmoil,
quickly became the unding currency or a vast new
carry trade as risk conditions at rst improved, and
then went into outright rally mode. he weak USD
story was an easy one to justiy: proigate public
sector spending in the ace o tremendous economic
weakness and a simultaneous heavy dependence on
oreign capital ows to keep its bond market aoat.
he avourite currencies to buy against the dollar were
emerging market currencies and commodity currencieslike the ustralian dollar
OutlOOk fOr 2010: whither risk aPPetite
anD the usD Carry traDe?
s we head into 2010, we have to ask ourselves
whether the global risk appetite esta and current USD
carry trade theme will continue unabated into the ew
Year or whether it is getting a bit long in the tooth al-
ready as we exit 2009. he answer is possibly both.
ur basic macro outlook calls or the rally in risk to
continue well into the ew Year as the market con-tinues to nd hope in the spectacularly easy monetary
conditions provided by the worlds central banks. hose
looking at economic undamentals will be encouraged
by some signs o improvement (a sel-ullling side
eect o massive stimulus), but these will be relatively
modest compared to the continued rank speculation
in asset markets. n such an environment, we should
expect lower yielding currencies with inerior growth
rates to suer currencies like the US dollar and Japa-
nese Yen. But other orces may be at work besides the
seemingly ubiquitous axis o risk in the ew Year,
and the USD may experience a resurgence o strength
on new themes.
Measuring the Carry traDe the saXO
bank Carry traDe MODel
During the year, we developed the Saxo Bank Carry
rade odel in an attempt to determine when risk
conditions are avourable or unavourable or carry
trades. isk conditions are a ubiquitous concern or de-
termining the direction in many currencies over the last
several years, particularly the JPY beore 2008 and the
USD ater. he model measures whether risk conditions
are expanding or contracting (in the chart, whether the
blue line is above or below zero) rather than trying to
determine any absolute level and thereore suggests
when the carry trade should be in or out o avour. he
second step is then determining which currencies are
most likely to benet and suer rom carry trading. he
chart shows a sample USD carry trade basket o the
USD vs. a basket o ve emerging market currencies
and UD and ZD. n the uture, the unding cur-
rency or the typical carry trade may shit (or example
to the JPY and/or CHf) even i carry trade conditions
remain positive or the market might nd it dicult to
justiy carry trades (outside o ) with rate spreads so
compressed. ither way, it is clear that tracking risk is
important or understanding the dynamics o currency
movements.
reMeMber glObal iMbalanCes?
t became clear during the credit implosion o 2008
and early 2009 that the enormous global imbalances
built up over the previous cycle could come unwound
very quickly i the market was let to its own devices. n
the second hal o 2008, ater all, the US rade decitshrank by hal in just a ew months - and the Chinese
trade surplus shrank rapidly in early 2009. nstead, cen-
tral banks and governments stepped in - just as they
always do - to alter the course o economic history and
keep the global imbalances alive, i in a diminished
size. US consumers (and thus the US trade decit) were
kept alive by a gargantuan fed-led housing bail-out
and easy credit and consumer demand on crutches
and Chinas massive stimulus kept the Chinese growth
engine humming, even as exports are well below the
pre-bubble days.
2 0 1 0 : B K U P H D P S f X ?
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Still, we think that the evening-out o global imbalanc-
es could return as a theme in 2010. current trends
remain intact in the ew Year, the US will post its rst
trade surplus, less petroleum, in 2010, and China could
be well on its way to becoming a decit nation in early
2011. ther nations are seeing similar reversals to
their terms o trade as well ustralias trade decit is
ballooning once again, and Canadas current account
surplus has gone steeply negative this year ater not
having posted a trade decit since the mid-70s, even
as crude oil surged back above $70 per barrel. ventu-
ally, the market may wake up to the reality that trade
and capital ows are not avouring an extension o
the market regime that dominated or much o 2009,
especially i the market begins to question the quality
and sustainability o the recovery as 2010 draws to a
close. Below, we will have a closer look at the 10 cur-
rencies in 2010.
usD: set tO reCOver eventually as Carry
traDe lOses its griP
he USD carry trade dominated the markets atten-
tion as summer yielded to all in 2009. s the low-
est yielding currency o the 10, and considering itsballooning public decits and a central bank engaging
in massive , selling the USD seemed a no-brainer
as risk conditions in global asset markets continued to
improve. nd while the correlation o the USD with
risk may hold or some time into the ew Year, new
themes may materialize that slow or halt this theme.
he cycles are always changing, ater all, and usually
just when something appears likely to continue orever.
ne troubling aspect o the USD carry trade is that it
may be more o an attractive concept than a reality.
real carry trade should see tremendous borrowingin US banks to nance investments around the world.
nd yet, credit is still very tight at US banks, which are
hoarding liquidity to deend against urther nancial
doom still on their balance sheets. hus, this carry
trade may be more about pure currency bets rather
than any outsized capital ows rom the US head-
ing abroad. Developments in interest rate spreads
also avoured the carry trade in 2009, but a dramatic
extension o interest rate spreads to the detriment o
the greenback may not materialize in the ew Year i
ination ails to ignite. he USD outlook is highly un-
certain or the initial months o 2010, but as the year
progresses, it could stage a strong comeback against
the rest o the 10 currencies as huge bets built up
in 2009 in avour o its demise are orced to unwind.
s or the fed, underlying economic undamentals are
likely to keep the central bank sidelined on rates or
the balance o the year, with more exit strategy ocus
on liquidity acilities rather than rate adjustments.
2010 rade: Sell UUSD. Sell UDUSD on rallies
ahead o parity.
eur: finDing the MiDDle Of the rOaD.
he euro nds itsel somewhere in the middle o the
pack as we exit 2009. t has done very well against the
USD since UUSD bottomed in early 2009 with the
ocus on the USD carry trade and as Chinas repegging
o its currency to the USD saw huge accumulation o
euros through reserve diversication. But i we look
over at a UUD chart, we can see how poorly the
currency perormed against more high-octane growth
currencies during the year. his kind o middle o the
road perormance is likely to continue into 2010. he
euro is overvalued against the USD, and as globalimbalances continue to unwind in the ew Year, the
pressure rom reserve diversication is likely to diminish
sharply. s well, rate expectations rom the CB are
likely to go nowhere in a hurry even though it appears
the CB really wants to tighten up monetary condi-
tions as quickly as it can. Conditions in the weakest
urozone economies like reece, Spain and reland, all
o which are stuck in the throes o a post-asset bub-
ble environment, are unlikely to be able to sustain a
recovery into 2011, especially i the CB moves quickly
ahead with reducing the ow rom the spigots asquickly as they appear to want to. So the urozone
may be at eventual risk o a double dip.
2010 rade: Sell U vs. BP and USD
jPy: will the jPy Carry traDe return?
he JPY was a curiosity in 2009. t began the year on
the strong side ater the debacle o 2008 on bets that
the world economy would continue to tumble into the
abyss. ate spreads had collapsed against BoJ rates,
thus removing much o the advantage o the previously
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popular JPY carry trade. isk aversion in general was
also associated with a stronger JPY. ven beore equity
markets bottomed, however, the JPY began to weaken
as the world realized that a weak global economy was
causing the most pain or export-dependent countries
like Japan and ermany and that a strong currency
would only compound that pain. So the JPY longs
were orced to back o early in the year. Since then,
however, the JPY has been a back-and-orth aair and
has largely ollowed the course o long US rates, a phe-
nomenon that may continue well into the ew Year.
s long as this new liquidity bubble keeps inating, the
JPY is at somewhat o a disadvantage, especially i this
translates into longer rates ticking higher. lso a poten-
tial JPY negative could be the uncertainty over how
the government plans to stimulate its way out o its
depressing return to deation. JPY may have dramatic
swings throughout the year as the market tries to get a
grip on whether it believes the recovery will trigger se-
rious ination down the road. s it is orced to realize
that disination is still the greater risk, perhaps by later
in the year, the JPY could stage a partial comeback.
2010 rade: Buy USDJPY or 100 to 105
gbP: the COntrarians PiCk?
BP suered greatly during the worst days or risk at
the beginning o 2009, bottoming against the rest o
the 10 currencies in late January and staying more
or less correlated with risk. When it became clear that
the world economy was not going to disappear into
the abyss, BP rallied, but then sold o again as it was
clear that the Bo wanted to remain one o the most
aggressive in keeping rates low and launching massive
measures to ght o a banking and credit col-lapse in its domestic market. his had the BP trading
at times like a avour o the USD carry trade as the
market had begun pricing in more hawkish monetary
policy elsewhere. asset markets continue on their ro-
bust upward path or most o 2009, then the pound is
likely to perorm relatively well, particularly as excessive
bearish sentiment on the currency likely means plenty
o stale sterling shorts that will need to be unwound as
the much talked about rmageddon or the currency
ailed to materialize. ne risk or the currency in the
ew Year could be around the general election, which
by law must be held by June next year. he prospect o
a hung parliament (no party with an outright majority
many consider this a likely scenario) is unsettling or
many, based on historical examples, and could cause
considerable volatility. Still, on a valuation basis, and
assuming that the bond vigilantes remain on hold or
a couple more years, the pound may do relatively well
against the broader market, especially versus those
currencies that have strengthened the most in the USD
carry trade.
2010 rade: Buy BP vs. U, CHf and ZD
Chf: snb May nOt neeD tO wOrry abOut
interventiOn
he SB decided to intervene in 2009 through direct
currency manipulation - threatening to sell rancs to
keep the risk o deation at bay rather than going
the route o the likes o the UK and the US. his
policy had the UCHf cross in a vice grip close to
1.500 or the last nine months o 2009. he Swiss
economy has come back rather smartly rom the
economic weakness and nancial meltdown that un-
olded, but we nd no strong reason to buy the rancin the ew Year. While the SB may eel condent
enough at some point in 2010 to declare its interven-
tionist policy is at an end, it is unlikely to move on rates
or become positively correlated with risk appetite. CHf
is likely, thereore, to tend to the weaker side o the
market in 2010.
2010 rade: Sell CHf vs. USD and BP
auD: high beta Chinese bubble traCker
UD has been the high beta currency par excellenceor a long time now. he currency was devastated in
late 2008 by the unwinding o carry trades and the
collapse in interest rate spreads or ustralia versus the
rest o the world. hese developments were radically
reversed in 2009, however, as the market was im-
pressed by the lack o collateral damage Down Under
rom the nancial meltdown and owing to ustralias
huge exposure to a resurgent China, which continues
to import key ustralian commodities at breakneck
speed. he ussie is the highest yielding currency in
the 10 and speculators (very crowded longs) are
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positioned or more o the same in 2010. While a con-
tinued surge in asset prices could see the ussie a bit
higher in early 2010, the currency is looking extremely
overvalued versus the broader market, and the sustain-
ability o the Chinese resurgence is questionable at
best. he second hal o next year may not be kind to
the ustralian dollar versus almost all o the rest o the
-10.
2010 trade: sell UDUSD on rallies. Sell UDCD
CaD: lOst in the shuffle
CD has shown little independent momentum against
the rest o the market in 2009 as it has ound itsel
caught between supportive and detrimental actors.
n the one hand, Canada is still a commodity currency
due to Canadas tremendous endowment o natural
resources and the nancial crisis showed that it had
the worlds most stable banks. n the negative side,
however, Canadas manuacturing sector has been
gutted by the weakness in the US auto sector, and the
weakness in the economy and currency o the US in
general, its dominant trading partner. persistently
low interest rate and a central bank belly-aching aboutthe strength o the currency could mean that gains or
the loonie will be hard to come by versus the green-
back in 2010. weaker oil market in the latter part o
the year could also be the source o urther weakness
or the currency.
2010 trade: Sell UDCD. Buy USDCD or 1.1500
nZD: Carry traDers lOOk Out
s o mid-December o 2009, the ew Zealand dollar
was the 10 currency with the highest 12-monthorward expected rate increase at close to 200 basis
points. his is despite the act that the CD recom-
mended that the countrys central bank keep rates
unchanged at 2.50% or some time to support the
ragile recovery. onetheless, the expected carry
advantage had the market bidding up the kiwi against
the lower yielders especially the USD or much o
2009. n 2010, the kiwis strength may continue or a
while, especially i the BZ moves orward with the
rst o an already priced in series o interest rate hikes
in the second quarter, but the orward trajectory o
rate moves appears overdone already. nd i the risk
aversion returns with a vengeance in the latter part
o the year, the combination o rate hike expectations
dashed and poor liquidity and economic undamentals
could prove an ugly cocktail or the kiwi.
2010 trade: Buy a basket o U, BP and USD vs.
ZD by the second quarter.
nOk: POtential never tO be realiZeD?
he orwegian krone tried to play sae haven or a
time in early 2009 as the fX market briey irted with
the theme o scal credibility a theme that probably
avours the krone more than any other currency due
to the countrys absurdly robust balance sheet and the
massive strategic reserve o the oil und. ter that,
the krone reverted back to being a measure o risk
appetite and tracker o the price o oil as well. n the
summer and autumn, the krone was strong on expec-
tations or signicant tightening rom orges Bank in
the year ahead. ater, however, the central bank made
it clear that it would not tolerate sharp speculative
strengthening o the currency and that rate hikes could
be cancelled i the currency was too strong. orgesBank is a bank to be taken seriously, considering its po-
tential repower, especially relative to the poor liquidity
in K crosses. n 2010, the K may perorm better
than the higher beta currencies as the year progresses
and could also gain a bit more ground on the euro, but
it will not live up to its ull potential due to the scary
presence o orges Bank and the thin liquidity o the
currency, as well as the potential or a weak energy
market in 2010.
2010 K trades: Sell UDK, Buy USDK
sek: better than eurO?
he krona has tended to ollow the wiles o risk ap-
petite and the strength o the global economy, due
to the tremendous importance o its export sector
or the countrys economic health. hus, the krona
was very weak in early 2009 on the global deleverag-
ing theme, but staged a airly strong recovery as the
market decided to put back on some risk. n added
twist or the SK has been its exposure to the Baltic
States, especially atvia, where its banks made signi-
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cant investments, much o which are likely to go sour
despite an f-led bailout, considering that countrys
attitude about repayment. Still, plenty o pain rom
the Baltics was priced into the krona long ago. During
2010, we would certainly preer the Swedish krona
to the euro as long as risk appetite remains on the
up-and-up based on the kronas tendency to ollow risk
appetite. But based on valuation, would also consider
accumulating SK vs. U on any downdrats in the
risk that result in kneejerk selling o the krona vs. the
single currency.
2010 SK trades: Sell USK or 9.75, buy USDSK
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lOng usDjPy Call
Buy 1 year, xp 8th o December USD Call Strike 107,
pay 85 JPY pips, (spot re 88.70).
ro: Weak undamentals in Japan, no rate hikes
in Japan in the uture, while the yield dierential to-
wards the USD might deteriorate, resurrecting the JPY
as a unding currency
shOrt eurCaD strangle
Sell 1 year, xp 8th o December U Put, Strike
1.4500, sell U Call 1.6800, receive 590 CD pips,
spot re 1.5600.
ro: UCD pivotal around 1,5500, the
break even o 1,3900 and 1,7600 covers nearly all
extremes topside and downside in UCD in the last
5 years, low correlation to the USDJPY trade, with the
USD stronger on 2010 the UUSD should go lower,
USDCD should improve and keep UCD balanced
around 1,55/1,56
shOrt eurtry Calls
Sell 1 year, xp 8th o Dec U Call, Strike 2.6800,
receive 530 Y pips, spot re 2.2200.
ro: ira undervalued in trade-weighted terms.
Y lagged other high beta currencies in appreciation.
fundamentally economy looks robust.
P D S f f X P S 2 0 1 0
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n equity markets we expect the cyclical recovery to
continue through 2010, providing additional support
or equity markets in rst hal o 2010 and in the sec-
ond hal o 2010 the strength o the recovery is to be
tested thoroughly by structural headwinds. We expect
the outcome o this test to lead equities lower.
ver the last two years markets have primarily been
driven by investor risk appetite. We expect this trend to
moderate somewhat and anticipate a more balanced
perormance between cyclical and deensive sectors as
investor ocus returns to undamentals and valuation.
furthermore, we expect to see a ight to quality on
single stock level led by a surge back to undamentals
investing.
arnings growth will drive equity markets, not valu-
ations. Despite this, there still is room or an expan-
sion o P/ ratios, we expect this to be limited due to
structural challenges preventing urther expansion.
We continue to see equity markets air valued, noting
that the rise in multiples during 2009 reect investor
expectations or an earnings recovery.
n regional level we preer emerging markets, are
neutral on US and urope and underweight on Japan.
ur preerence or emerging markets is primarily driven
by the expected growth in DP, which historically has
been transormed into earnings growth. But the corpo-
rate sector in emerging markets also appears healthier
than their developed counterparts; higher prot mar-
gins, lower leverage and improving asset turnover all
points towards that emerging markets are a premium
region (even though there are signicant dierences
within this region).
ur major play this year is to increase exposure
towards cyclicals, especially nergy in the rst hal
o 2010 and then towards deensives in the second
hal o 2010. We expect a potential increase in equity
markets until mid-year 2010 and in past market rallies
o this magnitude cyclicals have clearly over perormed.
However rom mid-year and towards year-end 2010
we expect risk-aversion to re-enter the market as the
market starts to adjust itsel to an environment with
higher interest rates, higher taxes, problems with com-
mercial real estate, resets in ption-s in the US
housing market.
earnings OutlOOk
We orecast decent earnings growth across all regions
(especially in emerging markets) as in able 1 below.
However, as the orecasts show, there are signicant
dierences in the expected earnings growth across
regions and this is mainly due to dierences in our DP
expectations or each region. We arrive at the earnings
estimates by assuming a sales growth derived partly
rom a volume and selling price estimates coupled with
an estimate o the B margin.
U Y U K 2 0 1 0
t 1: arnings rowth forecast ex. financials.
us
(s&P500)
eop
(Djsoxx600)
jp
(n225)
eM
(MsCi eM)
Sales rowth (YoY) 6.2% 4.7% 2.6% 10.4%
B margin (level) 8.1% 11.2% 7.5% 12.3%
arnings rowth (YoY) 13.1% 15.0% 8.8% 21.0%
s should be expected our top-down estimate o
earnings growth is lower than the consensus bottom-
up estimate. he gap is mostly a result o our lower
margin expansion orecast, as top-line growth assump-
tions are only marginally dierent. Consensus orecast
imply aster margin expansion than in the previous two
earnings recoveries even though the starting point or
margins are already above the historical averages. ur
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expectations o lower DP growth than ater previous
recessions make it dicult to justiy a record-breaking
margin expansion. lso consensus orecasts imply mar-
gin expansion in every sector, which did not happen
during the earnings boom o 2003-2007.
sales grOwth
Sales growth can come rom two sources: olume
growth and price growth. n aggregate, volume
growth in the corporate sector is driven by real DP
growth. ur economics team orecast limited growth
in urope, US and Japan, while they expect signi-
cantly more growth in emerging markets. Using a
regional split o sales or each o the regions corporate
sectors we arrive at a volume growth estimate or
each o the regions. We expect the volume growth in
urope to arrive at 2.6%, in the US 4.1%, Japan 2.0%
and 9.4% in emerging markets.
forecasts or price increases that the corporate sector is
likely to be able to push through have to be based on
expectations or ination. ur economics team expects
consumer price ination to remain subdued next year,
at 0.8% in urope and 1.6% in the US, -0.5% orJapan and 4.9% in the emerging world. course not
all companies sell directly to consumers so PPs and
commodity prices also orm part o our price growth
orecast.
We assume increased operational leverage. ggressive
cost cuts by uropean, US and Japanese companies
are enhancing eciency, i.e. more products can be
produced or less variable cost. elatively inexible
labour costs have also decreased, but naturally less so.
for instance in urope in 2008, xed costs accountedor approx. 28% o total costs or the companies, but
or 2010 we estimate that the share o xed costs rises
to 30% o total costs, increasing operational leverage.
cross regions we expect a similar development to take
place.
But it is important not to get carried away regarding
the benets o operational leverage. aturally it takes
volume growth to have large positive impact on bot-
tom lines. We expect volumes to increase decently in
urope, US and Japan and somewhat more in emerg-
ing markets; however this is not quite enough to cre-
ate the same kind o operational leverage boost as in
the previous two cycles in urope, US and Japan but
it could very well be the case in emerging markets.
Margins
s a result o the above, we expect B margins or
the uropean, US and Japanese corporate sector to
reach levels around 11.2%, 8.1% and 7.5%, while we
expect the corporate sector within emerging markets
to expand by 12.3%. his orecast implies that margins
will expand by slightly less than in previous two cycles
except or emerging markets, both o which were
accompanied by signicantly greater volume growth.
History shows that volume growth is one o the key
drivers o margins, which can be explained by the e-
ects o operational leverage.
When discussing margin expansion in 2010, it is
important to keep in mind that margins are already sig-
nicantly above historical averages in urope, US and
Japan and emerging markets. n 2007, uropean B
margins reached a record o 13%. argins then con-
tracted during the recession, but thanks to impressive
cost-cutting eorts margins troughed above the levels
we had anticipated and led to the beating o earnings
expectations in both 2 and 3 2009. t approxi-
mately 10%, the 2009 expected uropean B margin
is already 1% above the 25-year average. iven that
prot margins should in theory be (and have histori-
cally been a mean-reverting time series) the scope or
uture margin expansion seems generally limited.
nother argument as to why we do not expect the
B margin at least or urope, US and Japan toexpand signicantly is the relation between capacity
utilisation and B margin. he absolute level and
change in capacity utilisation has a direct impact on
corporate margins and volume; historically the path o
B margins has tracked closely with capacity utilisa-
tion levels.
he current collapse in capacity utilisation to record
lows has been accompanied by a record contraction in
margins. he rapid decline in utilisation reects a pull-
back in demand. s companies cut back on production
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to meet lower levels o demand, margins suered rom
reduced volume to cover xed costs and diminished
pricing power. ur expectation or a modest recovery
suggests that capacity utilisation rates should rise dur-
ing the course o 2010, but will remain at somewhat
depressed levels or a number o years.
valuatiOns
n December last year and in arch this year, equi-
ties looked very cheap by most metrics. arket P/s,
whether based on trailing, prospective or cyclical ad-
justed PS stood at multi-year lows, while the markets
average dividend made all-time highs in most regions
(both including and excluding nancials). But ater
this years signicant market rebound most valuation
metrics have normalized as demonstrated in the Chart
1 below.
he US CP (cyclically adjusted market P/) has revert-
ed to its long term mean o 16x, ater hitting 25-year
low o 12x in early arch. n urope the market CP
also rose, but less dramatically, rom 9x to 13.5x.
he expansion in orward market P/s was even more
dramatic, as a result o signicant PS downgrades and
rising equity markets at the same time. n urope, or
instance, the 12-month orward PS has been revised
down by nearly 40% since its peak in ctober 2008,
which contributed to a near doubling o the orward
market P/. s a result, the orward market P/ has
also reverted to its mean. ost o the other valuation
measures have also reverted to their mean. So in total,
most valuation measures suggest that equities across
all regions are close to air value, given that historical
averages are a reasonable proxy or air value.
0
80
60
40
20
100
120
140
160
180
Current as a % of 20 year average
P/EEUR
P/CFEUR
P/BookEUR
CapeEUR
P/CFUS
P/BookUS
CapeUS
P/EUS
P/CFJP
P/BookJP
P/EJP
P/CFEM
P/BookEM
P/EEM
C 1: P/, P/Cf, P/Book and CP or all regions current as a % o 20 year average.
soc: boom, tomo-r Dm, sxo b s & rc.
no: t oom o 1998-2001 xcdd om cco.
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further P/e eXPansiOn?
he key question or expected equity returns is the
potential or P/ expansion. Can share prices rise
over and above the expected rise in PS? s long as
monetary policy remains accommodative and inations
expectations remain benign, history suggests that the
answer is yes. here has been a loose, but unmistak-
able inverse relation between market P/s and ination
in the past as documented in Chart 2 below.
ndeed below-average bond yields and/or ination
have been associated with above market P/s. iven
that the current market P/s are in line with their
historical averages and that yield ratios are still belowaverage, there is urther room or equities to rerate.
his implies that equity markets could easily rise ar
more than what is given by our PS est