This is the time of the year when strategits  make annual forecasts. We have already seen a wide range of forecasted outcomes but we would like to summarize the consensus :

• Muted Recovery but Recovery
• Equity Markets up
• Short Long Term Bonds
• Long Commodities
• Certain Volatility
• Inflation

We do not see the economic events of the last two years as a classic Recession/Recovery phase. So we think that the possible outcomes are very uncertain.

But let´s try to Forecast  (do not forget that we are humans ) :

This recession was unlike any other we have experienced since the Great Depression. Typical recessions are inventory-adjustment recessions, caused by businesses getting too optimistic about sales and then having to adjust. You get temporarily higher levels of unemployment as inventories drop, and then you get the rebound. It is not quite as simple as that, but close enough. This time is more about credit expansion and contraction.We are in a post-credit collapse that is ongoing…

This recession was caused not by too much inventory but by too much credit and leverage in the system. And now, we are in the process of deleveraging. It is a process that is nowhere near complete. While the crisis stage is over (at least for now), there is still a lot of debt to be retired on the consumer side of the equation, and a lot of debt to be written off on the financial-system side. And this is true in US and in Europe as well.

Given the high rate of delinquencies and charge-offs of all sorts of debt in US, it is unlikely that we are going to see growth in loans in 2010. Consumers are working hard to reduce their debt. The New Frugal is part of the New Normal.

Past post-recession expansions have been built on growing credit and leverage. That will not be the case this time. We are going to see reduced lending and borrowing. Even though the federal government is running massive deficits ( US ), the stimulus portion of the debt will be running down in the latter half of 2010. There will be little political will to continue with massive stimulus and deficits. While this is good in the long run, in the short run it will reduce GDP.

Perhaps Inflation is a consensus forecast but Deflation is the present day reality and often lingers for years following an asset and credit bubble and further collapse.

We see the range of outcomes in the financial markets and the economy to be extremely wide at the current time.But a clear strategy is being defensive and minimizing volatility and downside risks and focus on where the secular fundamentals are positive such as equity sectors that lever off the commodity sector.

We are going to take a break for the next two weeks and recharge batteries, but we will be ready to go as 2010 comes around.

We wish you Happy Holidays and a great Year ahead…

THE PIGS ( Portugal, Ireland,Greece & Spain )

As it is well known, the biggest problem economies in the Euro-area are Ireland, Spain and Greece, all of which are mired in debt and economic malaise.

The Irish economy, with a debt-to-GDP ratio forecast to rise from the current 66% to 96% by 2011, is obviously in miserable shape, but at least the government appears willing to take painful and politically risky measures–massive wage cuts and income reductions are being implemented across the spectrum, in tandem with proposed tax increases on income and levies on public sector pensions.

In Spain and Greece, by contrast, the governments still appear resistant to hard choices that might help them tackle their debt, which in Greece’s case is forecast to rise from the current 112% to 130% of GDP by 2011. Within weeks of winning the country’s elections in October, the Greek socialist government raised the budget deficit forecast to 12.7%, twice the previous government’s forecast.

Spain’s debt to GDP ratio at 55% is below the European average, but it is suffering the ongoing effects of a major housing bubble implosion. Yet unit labor costs in Spain rose +0.4%YoY in the third quarter despite an 19.3% unemployment rate. More worrying are the fears that European banks in general and Spanish banks in particular have been slow to write off bad assets (how could Spanish banks have managed to largely avoid Spain’s massive housing bust?).

With these concerns coming, we see another reason to sell the Euro vs the US$, though the coming decline of the Euro from the current very overvalued levels will not provide countries like Ireland and Greece much relief in the near future.

After all, in terms of their real effective exchange rates, these two countries, along with Spain, have appreciated the most in the past decade.

The Black Swan

by James Merrill

Black on flat water past the jonquil lawns
Riding, the black swan draws
A private chaos warbling in its wake,
Assuming, like a fourth dimension, splendor
That calls the child with white ideas of swans
Nearer to that green lake
Where every paradox means wonder.

Though the black swan’s arched neck is like
A question-mark on the lake,
The swan outlaws all possible questioning:
A thing in itself, like love, like submarine
Disaster, or the first sound when we wake;
And the swan-song it sings
Is the huge silence of the swan.

Source: Albert Edwards

Complacency can be the name of the game. It seems that Investors have forgotten everything that had happened since 2007. Since March 2009 we have enjoyed a stock market rally based in the heavy hand of government intervention and stimulus but investors doesn´t care… Today´s  bullishness is dangerous…

2010 can be a disappointing and tumultuous year. The credit collapse and the accompanying deflation and overcapacity are going to drive the economy and financial markets in 2010. This recession is quite different from  the recessions post WWII experience because it is NOT an inventory cycle problem . It is a credit contraction related to households and small businesses  that will take a LONG time to heal…

So we recommend prudence and patience for the year that comes, that BTW is the YEAR of the TIGER ( Chinese horoscope ).