Please, click here to read this article in pdf format: december-11-2009

It seems that in the last 24 hrs, the world has put the ongoing confusion in perspective, and become a bit more optimistic on the outlook for 2010. At “A View from the Trenches”, we remain optimistic.  Too many times, we have written that liquidity remains intact and that as long liquidity is not affected, the rally will continue.

Now, although liquidity is out there, the underlying force behind it, fiscal deficits, is also alive. From the research that I read and comments that I heard in the last days, I feel analysts are underestimating this issue. There is a widespread expectation that volatility in 2010 will be more muted. But if the growing trend in fiscal deficits is to be broken, something of consequence needs to happen. And when something of consequence happens, expectations must be reassessed, which hardly represents a picture of muted volatility. Thus, for me to remain bullish entering 2010, I need to see that the fiscal gap is manageable, that it is not a problem, because if it is, things are going to spiral out of control and rather swiftly.

All one can ask for is consistency, and so far, we have not seen it. Next year will give us an environment with a US Treasury issuing more debt (and with longer average duration), with a still unsolved demand for Agency debt (once the Fed stops its bid in Apr/10), with the Euro zone falling into pieces, and with creditor countries in Asia exacerbating the USD peg. This is barely a picture of muted volatility and higher valuations…

I am confident we will see effective policy action on all of these fronts. But, muted volatility? I don’t think so. I am also confident that there will be further monetary coordination in 2010, and consequently, I believe gold could underperform, according to our Thesis No.2. On this basis, in 2010 I am tempted to slowly shift my investments to USD denominated assets and give equities a chance (I see credit/fixed income a bit rich vs. equities).

Below, I show a chart (source: Bloomberg) with the US Treasuries (Active) yield curve. You can see the steepening move since the beginning of December. Please, do not ignore it. It will be a move of consequence.

Martin Sibileau