Welcome to the tough new world is our takeaway from 2010 to date. Before the unfolding of the credit crunch from 2007 and even subsequently during the unleashing of advanced country government largesse, capital markets have been uni-dimensional. As global capital markets progress, we expect that a more classical and multidimensional investment world awaits. Relative predictability of easy money policy did give rise over the last decade and a half to quantitative tilts driven by long-short strategies and ostensibly creating alpha (with implications of a highly theoretical normal distribution world) that in their essence depend on stability. By contrast now, a more classical quantitative analysis backdrop could await which is commonly called Graham and Dodd in equities and credit assessment in fixed income even if its last form had as its background not just the Great Depression in the United States but also the Weimar Republic in Germany and colonialism in Asia—all conditions different from today. We would not quarantine the corrective tilt of 2010 so far. We believe that transparency in exit strategies from easy credit and that deficit management with large debt to GDP ratios (88% in Europe, 92% in the United States and 197% in Japan as reported in Der Spiegel February 5, 2010) transcend such quarantining as a Greece/Euro issue (or the derogatory broader acronym currently in use). It may be a symptom that forces broader change much as Thailand did over a decade ago, with the complacent including Japan seen in retrospect to have paid the highest price. Neither should the low quality tilt of equities in 2009 be seen as sustained, absent easy money. Only now in early 2010 has correction territory of a 10% pullback from peak for world equities and close to it at 8% for U.S. markets been broached. To us, it indicates a change in behavior potentially more towards quality of delivery and towards greater appreciation essential for the health of equity recovery is a strong financial sector with greater capital and less aid from government. We see quality of delivery as key and just as likely to be found in the restructurings of energy, industrials, information technology and healthcare for instance but unlike much current commentary, not necessarily sole purvey of staples in aggregate.

At the macro level and with widespread use of a derogatory acronym about the periphery of Europe, we detect a degree of frustration likely being generated by positioning that implicitly at least was based on a repetition of monetary conditions of the type seen post the start of the new millennium after 2000. It is useful to recall that even though easing conditions helped to assuage the pressures from the crash of 1987, in containing Latin American debt crisis, the U.S. savings and loan debacle, Japan as well as both the Asian crisis as well as Russia and LTCM, the subsequent period was substantially different from that being arguably expected both by governments and markets post the great ease of 2008/9. In particular with respect to sovereign debt and country restructuring, we believe the Asian debt crisis of 1997/98 has particular lessons. As currently in advanced countries, then in Asia (albeit for different reasons) free flow of capital was seen as inevitable and restrictions seen as the bane of lesser countries such as then highly regulated China and India. Much as with Greece today, Thailand was seen as a victim of its own chronic contradictions. However the reality turned out to be different. Politicians, central bankers and even corporate chieftains have an easier time dealing with largesse but are harder pressed to deliver quality. Some of the most complacent including in Japan can be seen in retrospect to have paid the highest price in both corporate and domestic terms while those engaged in the most extensive restructuring like South Korea turned out to be major beneficiaries not just in the clean out of finance nor just in the cleanout of its chaebols but in the emergence of quality in industries ranged from electronics to automobiles to steel to engineering. Similarly in Latin America as can be seen today, in many ways Brazil emerged far stronger than Argentina or Mexico or Venezuela all of which at the time were more complacent. Similarly, simply a large population blessed with resources was not a palliative as seen in comparing after the fact, Russia and Indonesia say compared to China and India both of which chose to deregulate industry generally and to clean-up moribund financial systems. We believe that transparency in exit strategies from easy credit and that deficit management with large debt to GDP ratios (88% in Europe, 92% in the United States and 197% in Japan as reported in Der Spiegel February 5, 2010) transcend the simplistic view of quarantining credit concerns as a Greece/Euro issue. Those concerns that may be a symptom forcing broader change much as Thailand did over a decade ago.

Usually among the more growth oriented segments of capital markets in both highly controlled economies like China or more laissez-faire such as the United States or in between, equities have recently in 2010 demonstrated an unusual characteristic—namely declining or becoming skittish as central banks and governments hint at the termination of public largesse. Highly correlated in movements both in decline earlier and then in recovery from early March 2009 and with a definitive low quality bias, this performance indicates to us that momentum rather than the quality of delivery was playing a dominant role, even taking into account the classical relief that normally accompanies a bottoming out of earnings. This development was more or less experienced across world equity markets into late 2009 and indicates that implicit within the momentum play are likely expectations that have been widespread for a repeat of easy credit and seamless expansion conditions that appeared to be taken for granted from 2004 to as late as 2007. For some time, we have seen upcoming conditions as being different including our longstanding view of an earnings low for mid 2009 but also in our call for exceeding the prior peak in S&P 500 earnings (2006 in the last cycle from a low in 2001) taking longer than in that cycle of easy credit. Corrections and rolling restructurings including those of operations and of balance sheets ( to a more conservative mix) have been expected by us to play an important role, much as took place in the late 1980s into the 1990s. In the event, only now in early 2010 has correction territory of a 10% pullback from peak for world markets and close to it at 8% for U.S. markets been broached. To us, it indicates a change in behavior potentially more towards quality of delivery and towards greater appreciation that a strong financial sector with greater capital and less aid from government is essential for the health of equity recovery. We see quality of delivery as key in general and just as likely to be found in the restructurings of energy, industrials, information technology and healthcare for instance but unlike much current commentary, not necessarily sole purvey of staples in aggregate.

Source:The Economist, February 3,2010