SAXO Outlook 2010

8/14/2019 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

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6

02-01-1990

VIX Index, RHS Credit Spread (Moodys BAA Rated Corporate Bond over 30-Year Government Bond Yield), LHS

02-01-1991

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02-01-1994

02-01-1995

02-01-1996

02-01-1997

02-01-1998

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02-01-2004

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14/40

OutlOOk 2010 Y f f

14

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

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01-01-2009

01-05-2009

01-09-2009

US Bank Credit Outstanding

Euro Area Loans to Non-Financial Sector Outstanding


15/40

OutlOOk 2010 Y f f

15

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


16/40

OutlOOk 2010 Y f f

16

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.


17/40

OutlOOk 2010 Y f f

17

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


18/40


19/40

OutlOOk 2010 Y f f

19

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


20/40

OutlOOk 2010 Y f f

20

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.


21/40

OutlOOk 2010 Y f f

21

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 ?


22/40

OutlOOk 2010 Y f f

22

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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OutlOOk 2010 Y f f

23

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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OutlOOk 2010 Y f f

24

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-


25/40

OutlOOk 2010 Y f f

25

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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26

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


27/40

OutlOOk 2010 Y f f

27

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


28/40

OutlOOk 2010 Y f f

28

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


29/40

OutlOOk 2010 Y f f

29

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.


30/40

OutlOOk 2010 Y f f

30

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

Documents

SAXO Outlook 2010