Currently, market behavior appears indicative of a process of re-establishing standards when looking to 2010 and beyond. Our assessment applies broadly from currency in dollar recovery to fixed income in debt assessments like Greece to mixed equity markets to other asset classes like commodity volatility as well as to government and corporate behavior. It would be a significant development, likely still to include volatility. The no standards approaches of 2008/9 and arguably earlier seem neither realistic nor sustainable. The transmission mechanism from credit duress to bank duress to sovereign rescue and risk has a long history in finance. Still, as long ago as 2006, progressive de-regulation by governments and concomitant splicing away in risk premiums by market participants was laying the ground work favoring broad based momentum over relative valuation assessment. The breadth of duress transmission has been clearly wide. However and despite spectacular failures, the late 2008/early 2009 rush for quantitative ease may have, perhaps not unintendedly, reinforced the tilt for momentum albeit into the upside. Now from late Q4/2009 continued into mid Q1/2010, the mixed equity market response to earnings momentum and the travails of government sponsored enterprise as well as deficit finance likely have as key takeaway the potential return of relative valuation assessment in cross section as well as across time. It has profound implications for portfolios but also for in the modus operandi of governments, central banks and corporations, all in favor of quality of delivery.

Central banks and governments alike need to become less concerned about appearing internationally cohesive on concurrent policy and re-establishing focus on future policy positioning. At the very macro level of currency and country zones, some developments especially in currency markets are indicative of diminished risk of crisis as a result of market disruption. The still tentative nature of global recovery has been indicated by fragile U.S. consumer confidence, by slow European growth and directionally for exporters by Singapore GDP contraction for Q4/2009 as well as over lending risk in China with inflation risk in India. We have long discussed as a measurable standard the risks that emanate from currency fissure of the type experienced ahead of the broader capital market break of 1987. In our view, U.S. dollar decline versus the Euro especially but also the Yen was a potential source of market disruption risk and not the benign development being commonly espoused as late as 2009 and through much of global economic upswing into 2007. While from a political as well as economic viewpoint, the yen remains stubbornly strong against the still dominant currency of international trade, the decline of the euro to now $1.36 has reduced the equivalent to 1987 fragility risk that we have long identified as being close at the $1.50 level.

Not just in the US dollar and euro but also in sterling as well as in smaller and in emerging currencies, capital markets appear already signaling that policy cohesion is likely to count for less going forward than is the re-establishment of strong stewardship that accommodates differing policy stances. Major advanced country central banks appeared to converge to narrowly focus on interest rate and liquidity measures. After cohesion about such quantitative ease from late 2008, policy evolution did appear in late 2009 as some central banks initiated very modest rate increases. In curbing further policy differentiation, currency gains appear to have become an implicit factor but we would favor those willing to be more independent. Instead of being a drag, even for exporting manufacturing nations like Japan and Germany, history demonstrates that strengthening currencies enhance efficiency, quality and hence prosperity. As another example and despite its economy being both closely U.S. and resource linked, in gain in the 1990s through the 2000s with well executed monetary policy and fiscal prudence, Canada was far more robust than the fears of Armageddon of some to be the consequence of a currency move from lows around U.S. $0.70 to close to parity. Other smaller countries with far fewer problems today such as Australia and Switzerland would be well served by clear policy that enhances efficiency over focus on currency. The emerging economy central banks of China and India have been using an array of monetary tools, including reserve requirements. With robust economies, both would be well served to not be caught in the obfuscation of major currency zones and instead further tailor individual policy which in the case of India would mean higher interest rates and in the case of China of continuing to follow up tighter reserve requirements but also then also allowing its currency to rise.

Credit duress leading to bank duress to sovereign rescue has long been a classical script but there now exist modern twists specifically wrought by globalization. Now, fixed income markets are at only the initial stages of re-establishing standards of risk premiums. A commonality to the debt issues of this crisis has to do with wink- and- nod assumptions of guarantees of which Greece is the latest symptom and well beyond being a European issue. In the stretch for return, investors, sophisticated like central banks and individuals alike, were willing and governments ready to not shatter impressions of linkages. Specifically, in the United States, mortgage finance and government sponsored enterprises (GSEs) appeared in their heyday to benefit from the aura of implicit support but in duress now, have yet to pass the hurdle of being re-capitalized with the Federal Reserve yet to fully enunciate a policy of exit from unusual support. There exist further similarities in the crises over Dubai and over Greece. In both cases, the amount of re-finance is small relative to the size of the potential overall currency block. The real issues are that benefits of monetary union were accrued on wink- and -nod without the other side of fiscal standardization being delivered. As in prior crises, global slowdown has exposed faulty assumptions with would be benefactors less than impressed by the collateral offerings of rectitude. By contrast, in prior Latin American and Asian crises and even the sterling crisis of 1976, the involvement has yet to occur of the IMF establishing benchmarked standards. Also well within the memory of knowledgeable policymakers and investors, whether accompanied by so-called structural or cyclical deficits, debt at close to 90% or more of GDP increases toxicity as interest payments transition into overwhelming tax receipts—a recipe also of political crisis as taxpayers experience ever fewer incremental tangible benefits from government.. With the U.S. dollar, yen and euro as well as sterling zones now at or above these levels, deficit standard re-establishment already has urgency beyond the peripheral economies of Europe per se and ripe for market discipline risk premium adjustments—a calculation arguably not well understood by Greece. That potent mix into the 1980s did push Canadians into sustained support for a mix of taxation and expenditure controls leading to lowered levels of debt to GDP, public sector unrest notwithstanding. The same may now be forced globally with the advantages lying with those already so positioning—hence our support for smaller currency countries being more focused on appropriate policy and less on consensus behavior.

In equity markets, the commonality recently has been of a return of volatility with close focus on day to day economic releases. The company earnings release calendar has now shifted to include substantive releases from outside US based companies but the message has been the same— namely that earnings have failed to impress especially when derived from cost cutting alone and not from revenue gain. We are reminded of an unusual investor forum that we attended at a similar turning point for companies in the aftermath of restructuring required as a result of the 1980s. The forum was unusual in that the treasurers of two major conglomerates actually engaged in a discussion of business policy. That of the newer, more brash but now defunct conglomerate espoused practically exclusive reliance on a set criteria of measurable return by division while that of the decades old, evolving conglomerate, still in existence today, explained that key was maintaining standards of the quantitative variety like return on capital but also of the qualitative variety such as inter-relationships. Post 2000, this lesson was to be re-learnt between the brash and the systematic in information technology with benefits that are still emerging today. It is likely to be re-learnt in finance as re-capitalization evolves into changed practices. It remains to be seen whether it occurs in the hard pressed healthcare space but we do expect benefits from the long pedigree of the pharmaceuticals and the product delivery of biotechnology. We believe recent momentum behavior notwithstanding, the relative valuation aspects of equity to be making a comeback.