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

As anticipated on earlier letters (December 2009), in 2010 I expect the continuation of the ongoing asset appreciation trend. I had also disagreed with the mainstream view that volatility was going to average down in 2010. A week is gone and I am losing on that one. However, the view of high volatility in 2010 is based on my concern that, regardless of the strength of the monetary stimulus, sooner or later, governments will have to show investors that a fiscal restructuring is undertaken.

Since Friday, I am starting to believe that this restructuring will be required sooner rather than later. This of course implies that markets are getting ahead of themselves…and I hate myself whenever I arrive to this sort of conclusions.
The speed at which credit spreads are compressing, the resilience in sovereign credit spreads vis-à-vis red flags coming from China, Greece, Ireland, Mexico, Venezuela, the US housing sector to name a few, tell me that something will have to correct sooner, rather than later.

As we have the privilege of having about six decades of Keynesian economics behind us, we may understand how the system works. Governments will refuse to restructure and will follow the path of least resistance. Governments will issue and issue and issue and issue until investors tell them to stop voting with their feet. Whoever bets on 2010 as the year of the liquidity drain, I think will be disappointed. I include myself in the group of those who thought a few weeks ago, that a slow but steady decrease in liquidity was going to occur. Yes, we will see liquidity programs unwind but we will see other more subtle and indirect ways of credit expansion.

The case of Greece, with private placements sustained under the silent and  hidden support of the European Central Bank is only one of the forms liquidity will remain offered. In Venezuela, we just learned that Mr. Chavez likes a more direct and explicit approach, with the announced 50% devaluation of the Bolivar. In Argentina, the federal government had absolutely no shame in requesting reserves from the Central Bank to pay upcoming debt maturities. In the US, the Treasury is getting ready to capitalize its GSEs (government sponsored entities) when these start to suffer from increasing mortgage delinquencies. In Canada, we keep telling ourselves we have the best financial system in the world, when we failed our asset-backed commercial paper investors and still require approx. C$1BN /week in repurchase agreements from the Bank of Canada to subsidize inefficiencies. Furthermore, we are in total denial with respect to the clearly skyrocketing fiscal deficits.

In this global world, it is a mistake to think that problems in the periphery do not affect us in the developed world. Episodes in Dubai, Venezuela or Argentina are only symptoms of a truly global problem. In the meantime, the path of least resistance will be supportive of equity and credit here in North America, of commodities and commodity related currencies and the capital structure trade we mentioned in our January 4th letter will continue to unfold relentlessly. Not necessarily of gold.

I want to stay alert and as liquid as possible. Most analysts tell you that 2010 is no longer a “beta” year and that alpha will be achieved by….well, by chasing alpha strategies. For you and me, this means that to be able to get stellar results, we will have to be picky with our investment choices, looking for solid fundamentals to outperform the market. If my diatribe above is correct, these analysts are delusional and actually never quite understood why things rallied in 2009, in the first place. If I am correct, the risks you will avoid by being long liquid beta assets in 2010 will more than offset whatever alpha you think you may get by abandoning liquidity.

Martin Sibileau