1 Month Down: Thoughts About the Rest of 2010

The first month of 2010 kicked off the year with the S&P going down more than -3.5%. Some Bears may have been excited by the fairly consistent sell-off that they saw all through the month of January. Although I remained bearish myself as the 2009 rally raged on, I would caution investors & traders about coming to a quick conclusion about January's market action. Though, I remain a skeptic on the rally of 09 and I do expect the return of the Bear at some point, there are many things to consider as we go forward in 2010. One big one is the ongoing tug-of-war between inflation and deflation.

THE TUG-OF-WAR (Inflation vs Deflation)

I would describe the overall theme of the US Economy as a constant Tug-of-War between Inflationary forces and Deflationary forces. Despite the surging stock market in 09 the "Real Economy" was downright ugly and remains so. Consider the facts... Foreclosures continue to set new records, Consumer Credit continues to contract with more and more credit card write-offs piling up, The official Unemployment rate stands at over 10% and real Unemployment is somewhere between 15-20%, People who still have jobs face a much more challenging environment in regard to promotions and salary increases (Wage Growth is Severely Muted), Small Community Banks and Large Regional Banks that don't fall under the "Too Big to Fail" category will continue to fail at a rapid rate, also the Commercial Real Estate market continues to show signs of deteriorating and remains a big risk-factor for a Financial System that hold loans and securities tied to CR. All of these facts and others not mentioned are representative of the immense Deflationary pressures (Defined by me as Falling Prices for goods & services and a falling/crashing stock market) at work in the economy.
While these forces are very real, very powerful, and won't go away over night, a decisive and prolonged period of Deflation is not necessarily the guaranteed scenario that some believe it to be. Believe it or not Inflation is just as real of a threat to the current economy in 2010 and the next several years after. Due to the Deflationary pressures mentioned above and the Financial Crisis of 2008, the Government and the FED have taken unprecedented actions to restore stability to the financial system and set the Economy back on the Growth track again. My belief is that the Government will stop at nothing to fight against the economy falling into a deflationary spiral. I also think that the Government and the FED (Especially the FED) actually want to create inflation right now. Various reasons fuel this desire. We are the largest debtor nation in the world and devaluing our own currency is one way the US can alleviate the burden. The high Unemployment rates and depressed standard of living brought on by Deflation equals social unrest and social instability in the minds of those who govern driving them to spend in order to stop it from happening. I would also point out that Government and FED policy have increasingly become influenced by the Ultra Wealthy/Wall Street class who benefit from inflationary policies that create asset bubbles. Some would disagree with the assertion that the Government actually wants inflation, but it is hard to refute that the Government and FED are waging war against Deflation and using Inflationary policies to do so. Therefore, I don't think that there should be any doubt that the current policy trends carry the risk of very high inflation rates in the years to come. For this reason investors should be cautious about being blinded by overly bearish views and risk being blindsided by an inflation fueled rally (bubble) in stock prices. If Inflation takes hold stocks are likely to continue rallying or rally sharply off of any sell-offs that may occur. One certainty in 2010 will be that this battle will continue raging and market participants would be wise to watch it closely!

OTHER THEMES TO BE AWARE OF IN 2010

Treasury Debt appears to be in bubble territory. With waning appetite from foreigners to finance America's ballooning debt load, there is a real risk of Interest rates rising sharply and treasury prices crashing. I am accumulating TBT (Ultra Short Treasuries ) in order to benefit from this.

Volatility is Likely to Make a comeback in 2010. Markets went straight up for most of 2009 and volatility went straight down. This is not likely to last forever. Especially with the many potential risks facing the economy. I plan to continue accumulating VXX to benefit from the eventual reversal.

The desire to diversify away from the US Dollar will continue to be a trend to watch in 2010. It won't be surprising to see countries like China, India and probably other emerging market countries making big Gold purchases and actively working together to break US Dollar hegemony. The trend in precious metal prices (Gold, Silver, & Platinum) will remain up for 2010. I also am expecting other commodities to do well, especially strategic ones like oil.

As the US and Europe continue to face challenges within their domestic economies and as a result follow risky government policies that increase their debt loads, Emerging market countries like China, Brazil and others will start will continue to look even more "Relatively Attractive" for business and investment. I am actively looking for opportunities for Long-Term investments.

Good Luck to all in the Year Ahead!

It should be an interesting one.....