Playing a Devil Advocate

In 2009, we can safely say that three inter-related trends have dominated financial markets – US$ dollar secular weakness, rally in commodity prices and a pronounced out-performance of emerging markets, including Asia. Question is that will these three trends to continue into 2010, as there are signs that they are to be running out of steam. For us, this begs the question whether the trends of 2010 will prove different to those of 2009, given what was happening in the Middle East recently?

The news of a Dubai World would be suspending payments to creditors, which was promptly followed by the rumor that defaulted Saudi groups – the Saad group and the Aran group were really nerve wrecking news and make many to think hard how the Middle East could find itself in this tight spot?

Of course, one argues that this may be nothing more than a few bad apples that blatantly mismanaged the liabilities and blew up balance sheets.

But I am also intrigued by the recent announcements that some of the region’s sovereign wealth funds – Qatar and Kuwait – have lately been selling the large stakes that they acquired in Western financials at the beginning of last year’s financial crisis. Of course, this could be guided by the simple fact that banks are back above their purchase price and they are happy to turn the page or perhaps, the sales are an indication that the Middle East needs US$ right now and that we are confronting some kind of squeeze on the US$.

One thing that I am very sure is that the recent developments in Saudi and Dubai will most likely give pause to foreign banks looking to expand their lending operations in that region. This raises question of whether the Middle East will look to pump more oil in a bid to generate the revenue necessary to keep the wheels churning? Could this be the beginning of financial squeeze in the Middle East that lead to the kind of massive cheating on OPEC quotas that we witnessed in the 1980s?

With these confluences development, where would all this leave other emerging markets, most specifically Asian equities, which have soared in the past year? Historically, Asian equities tend to struggle when the US$ rallies as a strong US$ forces Asian central banks, who typically run pegs or managed floats, to print less aggressively. But at the same time, most Asian economies would likely welcome the extra liquidity that lower oil prices would provide, not to say anything about an environment of continued low interest rates.

If that is the saying of the day, it is likely lead to massive rotation within the markets away from commodity producers and property developers and towards manufacturers and exporters.