2010 – Risk Taking or Risk Aversion

2009 is coming to a close. It is all about a tug of war between risk aversion and risk taking, dictated by what happening with global currencies, stocks, bonds, commodities and for most part of the year, the battle is clearly won by an increasing global appetite for risk.

After the global financial system was on the brink of collapse in late 2008, it became apparent in early 2009 that disaster had been averted. It was a green light for global investors to start dipping their toes back in the water. In a sense, risk trade has been easy to understand as the US dollar has moved one way and practically everything else such as currencies, global stocks and global commodities have moved in the opposite direction.

When risk aversion is king, the US dollar wins and practically everything else loses. And conversely when risk appetite improves, that trade reverses. Now that the perception that the US recovery is on track, market focus is beginning to shift back to the traditional drivers of capital flow – interest rate differentials and economic growth differentials. That’s why we are seeing the US dollar recovers recently, even while stocks and commodities move higher. A clear decoupling of the correlations we have seen to this point will define the risk taking component of the risk trade for 2010.

The issue now is the economic recovery that we are seeing so far is sustainable or not? We have seen the positive GDP numbers that have technically ended most recessions. But now the forces pulling and pushing between risk aversion and risk taking are about the sustainability of the recovery. If the recovery proves sustainable, then the market focus should ultimately transition back toward relative growth and relative interest rate prospects between countries.

But this argument has a lot of detractors. There are some very serious problems that remain and risks that make sustainable growth a low probability, in my view. Key threats include: (1)the rising prospects of a sovereign debt crisis, which was Dubai that stroke fear in the financial markets and now Greece, Italy, Spain, Ireland and Portugal – all are coming under scrutiny for the same reasons and it can be contagious to investor confidence.(2 threat of asset bubbles with new bubbles in real estate are popping up in the areas that were relatively out-performers in the downturn such as China, India and Canada. (3 rising protectionism on global trade and capital flows. Considering protectionism was a key accomplice in fueling the Great Depression, this activity represents a major threat to global economic recovery. As the issue with China’s currency gains in intensity, I expect protectionist acts to rise in retaliation.