The Big Trend for 2010

Investors will be risk averse, over-subscribing Treasury offerings by two to three times (as they have in 2009). Foreign central banks will buy Treasuries at little or no yield while the public sells equity mutual funds to buy fixed-income funds. Credit markets signal the future direction of equity markets, but no one ever pays close attention.

The U.S. recovery. Big bank stocks will continue to climb because of favorable interest conditions and, of course, unprecedented government support. The Treasury's ownership of warrants to purchase big bank stocks provide an incentive for the government to support big banking operations. Smaller banks will suffer from commercial real estate losses while the big players, supposedly off government assistance, will snap them up. This will be the largest banking consolidation since the 1990s.

The U.S. economy will pick up steam, but the gains will be unequally distributed. Job-seekers, those in overbuilt housing markets and low-skilled workers will suffer. Slimmed-down corporations and equity investors will thrive as growth accelerates. Emerging markets, by contrast, will suffer a jolt.

The Unconventional Wisdom

The Fed won't raise interest rates in 2010 because there is no expectation of inflation. The Consumer Price Index will be negative. The reason: They want to let Citigroup, Wells Fargo and Bank of America re-capitalize by borrowing money at .25 of 1% and investing in Treasuries at 3% with 20 times leverage. That's a return of 60% a year.

China will be exposed for lying about its GDP numbers and productive capacity while downplaying the squalor of the majority of its people. Emerging markets will remain firmly coupled with the U.S. economy. The death of American hegemony has been greatly exaggerated, but let's hope some lessons have been learned. Gold will fall and the dollar will strengthen without taking stocks down.

The asset that investors most hate today--the dollar--will bounce back. The asset they most love--U.S. Treasuries and other bonds--will get crushed.

The Misplaced Assumption

That emerging markets are good no matter what happens in developed markets. That notion is nonsense because so much hot money flows in and out of emerging markets, especially from hedge funds. At the first sign of trouble, they pull their funds out of emerging markets to reduce their leverage.

That a lack of credit caused the recession and that repairing the credit markets will fix the economy. The truly systemic problems are stagnant wages for too many Americans and a legal and regulatory system that favors large established companies over smaller and more creative enterprises. Fixing the credit system is a necessary but not sufficient step for a long boom recovery.

China is on the verge of emerging as the world's economic superpower. It is a bubble waiting to burst. When it does, in the next year or beyond, it will be exposed as a paper tiger with a flimsy backbone.

The Watch List

Sovereign financial stability: There will be more Dubais and Icelands. Greece, Spain and Eastern European troubles will hurt banks throughout Europe.

Wells Fargo and Citigroup (when will they leave The Troubled Asset Relief Program (TARP)); Goldman Sachs, JPMorgan Chase (which will rule Wall Street?); Timothy Geithner (will he last the year?); Ben Bernanke (Does he have an exit strategy?);

President Obama will lose the economic initiative as the nation realizes it needs healthy companies and bearable taxes to thrive. Citigroup will sell off major pieces of itself. Visa and MasterCard will face rising calls to cut their bank interchange fees. Morgan Stanley and Blackstone will disclose big losses in real estate funds.

The Bold Prediction

There will be no military attack on Iran because although they will get the nuclear bomb, they won't use it--meaning no oil crisis, no $200 oil and no inflation caused by high energy prices. Residential real estate will be the distressed investment flavor of 2010.

Some of the AIG traders tasked with unwinding credit default swap transactions will indeed get fed up with the pay limits and walk into better jobs at newly capitalized and expanding competitors. But it won't matter. Enough finance wizards are out of work who can replace them, and the skills needed for the job aren't as rare as some would have us believe. AIG will still be a major boondoggle for the American taxpayer and will count for the single largest TARP losses.

The political pendulum will begin swinging back toward free markets, with the 2010 midterm election the centerpiece of the movement.

Source: Forbes Magazine