We see a potentially substantive reset currently taking place through early 2010 amidst the yin and yang of flows and fundamentals that is inevitably part of any capital market dynamic but which markets chose to ignore as they embraced liquidity injections with barely a pause to assay the ramifications of greater government involvement. In fact, the urgency of heightened sensitivity to political economy changes can be tracked back to the budget in Japan presented in December 2009 with many to follow globally into the spring, with currently imminent both the U.S. Congressional Budget Office projections and the State of the Union address from President Obama needing to focus on the executable, unlike the aspiration tilt of that for 2009. Stubborn U.S. jobless releases, equivalently high unemployment in Europe and GDP contraction for Q4/2009 for Singapore for instance point to plodding global recovery. We believe that greater benchmarking of risk spreads is inevitable, not least in the government finance, as seen for Greece and still unfolding for Dubai. In the related world of financial regulation, unlike that at the inception of the Eurobond market in the 1960s for instance, currently jurisdictional arbitrage is unlikely to reduce risk oversight with many changes being hammered out for financials. Compared to our 15-18x P/E range as appropriate, we measure the S&P 500 as having entered earnings reporting season just slightly above on our 2009 and just slightly below on our 2010 estimates. It seems to us that markets baked in positive potential of momentum tripling for Q4/2009 ( versus a doubling indicated by early actual reports) and may now be resetting. These at a minimum call for reset of unbridled enthusiasm as well as for a quality tilt in portfolios.

The nascent cycle of recovery and capital market sustenance requires substantively more changes. Investors are likely to need and indeed should demand (even more than ever) concrete signals from imminent deluges of government budgets and corporate earnings releases. For portfolios, if not counteracted by both governments and corporations, we find a cycle of dependency a risk which more is usually associated with other socio-economic endeavors such as native communities, ghettos and farm subsidies. Even by prior experience, aspirations and standards now need to be higher than self-congratulation about softening required restructuring by spending trillions of dollars of other peoples’ and other generations’ money. We remain watchful that instead of underscoring confidence in their own abilities, in high growth countries like India and in recession ravaged Europe/United States alike, business organizations appear still weighing in on the desirability of maintaining government stimulus. We are also watchful that deficit control appears not to be given its rightful profile even amongst the more right wing authorities, with central banks equally continuing to signal low administered rates as being desirable. Re-establishment of risk premiums would be concrete indications of change after months of momentum behavior. In turn, we believe those countries and companies co-opting such change are likely to competitively benefit and hence have a quality advantage to be favored by investors. There is likely to be a stream of extraordinary budgets with pressure points already evident in recent weeks from Japan to Greece to Venezuela to Argentina with President Obama’s budget likely to have far higher scrutiny than his first one. In momentum since early 2009, versus a benchmark of 5% for 10 year U.S. T-Notes (incorporating a base with inflation and uncertainty premiums), its present yield is 3.78% with yields of BBB corporate bonds only 5.11% for instance. At the cusp of earnings reporting, investors need to be cognizant of the valuation impact of potential bond yields and the nature of the delivery content of the corporate earnings releases themselves. Our good friend Vincent Catalano (www.bluemarbleresearch.com) points to expectations of 80 for S&P 500 operating earnings for 2010 which if realized, would be well above ours of 75 and in our experience, one of the most rapid moves during a recovery of consensus from below to above our expectations. We have maintained a normality benchmark range of 15-18x for P/E ratios for the S&P 500 with the current market (1145) on annualized concurrent Q4/2009 slightly above this and on 80 slightly below this range. It seems to us that bifurcation could well characterize both markets and earnings delivery in the upcoming reports, even leaving aside the issue of write-downs and dilution in the financials.