Five lessons to be learnt from a forgettable year

Markets rarely have amnesia, but market-participants do. Every nascent bubble finds its niche, finds its proponents and the idea nurtures itself with self-reinforcing tales of promise and monetary redemption. So does, every tale of excessive pessimism. 2009 has been no different. Given the tumult and pace of events this year leaves little room for retrospection, far less introspection. It is perhaps thus apt that we take this opportunity to review some critical lessons, and their impact for 2010.

Betting on the beaten-downs:

Last December, the equity markets were in the doldrums. From March onwards, they made a rousing comeback. In the short run, the market's ability to assess oversold or overbought markets is relatively accurate. But, in the intermediate term, the same forecasting abilities are dubious.

In parts because what governs the trends are structural determinants - even if random events continue to buffet the price movement. What governs the short-term movements are "animal spirits" of exuberance and pessimism. To bet against excessive euphoria (as John Paulson did) and to bet against excessive pessimism (as David Tepper of Appaloosa Funds did) is the single most important lesson of the past two years, particularly so in 2009. The worst hit this year has been the US dollar and select commodities perhaps there is a lesson there!

Betting on emerging markets

For the first time some time late this year, emerging markets by Purchasing Power Parity measures were larger than the developed markets. It is increasingly clear that emerging markets have become an asset class that every staid investor shall buy into. Consumption, unlike investment, creates its own tiny feedback loops.

Locality specific innovations have emerged to create new micromarkets, and entrepots have flourished along with megapolises with their own set of problems and solutions. Markets have emerged in unexpected of places from northern Sri Lanka to northern reaches of China. To avoid investing in India, China, South Africa and Brazil is analogous to avoiding investments in computers in the 1980s.

Fads and forces

Structural changes are easy to locate. But more insidious and long lasting are changes to how we communicate, purchase and dispense with information. As faddish as social networking platforms like Twitter, Facebook et al seem firms and countries that adapt these changes will have greater volatility in their revenue and efficiency-per-unit-of-labour. Greater volatility implies the possibility of great rewards. 2009 was the year of consolidation of these technologies amidst global downturn. Any recovery will increasingly leverage these technologies to influence growth.

Political risk

Politically, with the rise of communication and information exchanges the need to differentiate ideologically has increased. From the United States' quasi-paralysed Senate/House to the rise of piracy off the Somalian coast increasedly we observe extremism on the rise. Much of this is strategic in nature to extract promises and access to resources for their own sub-groups. The lure of protectionism is writ large, especially in the United States. With the perceived "decline" of the United States the incentive to experiment in global world order is on the rise. Resultantly, political risk from strategic extremism is a factor that investment managers will actively study.

Central bank independence

In the early to mid 1990s, the de-facto assumption was the developed world had independent central banking systems. Alberto Alesina and Larry Summers had written extensively about the purported independence and the inescapable causal linkages with low inflation.

The idea that developed world's central banks are inflation targeters is, well, a myth in search of a reality. In essence, with the ambiguous agendas of global central bank between output stabilisation and inflation targeting we are now headed into unchartered territory as far as our modern post 90s hyper-connected world.

The coming year of the "great stabilisation" is in many ways the code-word for increased governmental sector in the economy. While privatization of wars occurs, loosened purse-strings of the exchequers are expected to continue. Countries with elections will find temporary rise in their equity markets, and most likely inflation. The spill over effect into the already oversold dollar market is widely expected as well.

In essence, while 2009 was the year of macroeconomic despair; 2010 ought to be the year of macroeconomic uncertainty. To many, uncertainty is preferable to despair.

The columnist works for a major European investment bank in New York City. You can follow his tweets at: http://www.twitter.com/ks172