Notes From Underground: Making Sense of an Unbalanced World

We are closing out a very tumultuous year in which we have seen wild gyrations in the prices of all asset classes. The global equity markets appeared to be heading into the abyss in March 2009, only to reverse and close with substantial gains for the year. Commodity prices also wildly fluctuated as deleveraging impacted most prices. Also, low interest rates and cheap money facilitated a move into hard assets in the second half of the year. The only asset class to post losses for the year are the global bond markets as the U.S., German, Aussie and Japan are all closing down. This makes perfect sense as investors moved out of the safety of government debt and into more risky assets. Now to be sure, with the exception of the U.S. sovereign bonds, the losses have been marginal. The losses in the U.S. sovereigns were greater because the rush to safety at the close of 2008 drove yields on the long end to unsustainable levels (barring a depression). As wild as the DEBT markets were in 2008, that performance pales in comparison to the equity markets of 2009.

For the year, we’ve seen great increases in the global equity markets. Taiwan is up 65%; Euro Stoxx is up 22%; Footsie is up 22%; Nasdaq is up 54%; the Nikkei 225 is up 20%; and the S&P is up 21%. The emerging markets surpassed these rallies, which posted gains of more than 50% with the Brazilian Bovespa leading the way, up more than 80%. (Yes, we know Russia was up more but it is a less liquid and more volatile market so we don’t rely on its outlier performance as a barometer.)

The global economy will have to experience substantial growth to support 2009’s gains. This will be the test for the central banks: To get sustainable growth without breaking the back of the fragile recovery. That is why Bernanke and his fellow 37ers are going to err on the side of maintaining monetary stimulus as long as possible. Being monetarists and having blind faith in their models, they fear a repeat of 1937, for as Bernanke told Milton Friedman: “Yes, we did it. We are responsible for prolonging the Depression and we won’t do it again.” This mindset is what drives the cheap funding of the equity markets and the steepening of the world’s yield curves. We believe that this has driven the move into real assets and especially keeps the bid to GOLD. The desire of the FED not to allow deflation is the main impetus that drives the desire for investors to protect their paper assets. This also prompts the buying of equities as the high yields on high quality stocks with low debt levels is certainly an attractive alternative, so the need to protect and sustain value is of paramount importance. Balanced risk will be the watchword of 2010.

The main news story was from the U.S., as its International Trade Commission moved in a 6-0 vote to impose import duties on $2.8 billion of Chinese steel pipe imports. In a ruling that found that China illegally subsidizes its exports of steel pipe, the commission granted the Obama administration the right to impose tariffs. The ITC is made up of three democrats and three republicans, all Bush appointees, so there is little political conspiracy here. This will not sit well with the Chinese and this tit for tat on trade issues has got to end, or we will end up in a trade war that will undermine whatever global recovery that exists. The trade actions will do more harm to economic growth than prematurely tightened monetary policy ever could accomplish. If anything could bring the equity rally to an abrupt halt, it will be the tariifs and monetary controls that are making its way into the policy discourse.

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