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.

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. Since last spring/early summer, in the aftermath of unprecedented government and central bank intervention, the surprise for us has been the unquestioning aggressiveness with which markets embraced liquidity injections with barely a pause to assay the ramifications of greater government involvement. The resultant expansion in equity prices globally, in real estate prices especially in Asia and low quality assets generally, including junk bonds, have had their genesis in confidence about seamless recovery. Valuations have appeared to leave little room for anticipatory bumps that are inevitably part of any change, especially one as searing as that following a credit crunch. While it remains to be seen whether a benchmark correction of 10% takes place as we have been advocating as healthy or whether it is another of several sharp pullbacks since market recovery engaged, we believe that at least into the spring of 2010, a surfeit of developments are likely of a political economy and of a valuation nature. These at a minimum call for reset of unbridled enthusiasm as well as for a quality tilt in portfolios.

In fact, the urgency of heightened sensitivity to political economy changes can be tracked back to the budget in Japan of December 2009 followed by the resignation of its Finance minister. Many more budgets will inevitably be presented around the world, inevitably with large deficits and transparency is likely to be an issue. Next, the authorities in China have become increasingly transparent in their desire for more metered credit extension, unlike in the first of 2009 when Chinese banks front loaded in effect their targets for the entire year. Last but not least, the stubborn U.S. jobless releases, equivalently high levels of unemployment in Europe and last not least the 6.8% quarter- over- quarter contraction ( led by manufacturing) for Q4/2009 for well managed but globally open Singapore point to plodding global recovery at best. At the macro growth level, markets have started to reconcile that domestic consideration for high growth areas such as India (with food inflation large) and China (on asset inflation) may be converging with still sluggish change in advanced economies. As just the first of many such releases in many countries, we expect the imminent Congressional Budget Office projections in the United States and the State of the Union speech by President Obama to be closely parsed not for the inspirational that characterized 2009 but for the more prosaic executable into acceptable long term policy. In that sense, the Massachusetts win by Senator elect Brown was not the cause of market reset in the United States but instead a signal of the likelihood of greater checks and balances in a market that had chosen to ignore such needs. Also in a discernable pattern of change, more clarity is emerging of the nature of emergency backing for Dubai from Abu Dhabi while in Europe, Greece has discovered that the benefits of a modern monetary system cannot be assumed to be extended into support for age-old fiscal practices. We believe that greater benchmarking of risk spreads is inevitable, not least in the government bond markets. 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 such financial changes being hammered out in individual jurisdictions as well as under the aegis in Basle of the Bank for International Settlements. The proposals of President Obama are the latest in a series from the United Kingdom to Switzerland designed to strengthen bank capital and reduce leveraged exposure to non-core risk assets in financial institutions—a marked difference from assumptions of business as usual that were hitherto were being made in the markets despite the proximity of the 2007 credit crunch.

Commencing in the United States and to become a deluge in the upcoming weeks, earnings are being reported. We stand by our long stated cycle call of an earnings bottoming out in early2009 to be followed by recovery in the environs of fiscal 2011 back to the peak of 2006. However not withstanding the momentum satisfaction of finally recording year-over-year gains as Q4/2009 results are being reported, this stance is and remains at variance with the aspirational expectations of the markets of recent months that have appeared to be closer to those for even sharper gains. Interestingly, the early reports for the S&P 500 appear to incorporating a close to doubling of operating results from the depressed levels of Q4/2008 but we would judge that even for our estimates, a close to 150% momentum gain would be required and for consensus arguably closer to a 200% plus gain – but these expectations appear being tempered down. Interestingly, we observe that even in a relatively less scarred sector such as information technology (let alone hard pressed banking), strong earnings momentum early releases in early 2010 failed to move up stock prices of the concerned companies as disparate as those from U.S. based and Indian based companies with similar accounting. 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 and may now be resetting in assaying some of the challenges from revenue growth realizable potential to very real political economy change globally.