Deutsche Bank recently released their 2010 investment outlook and although they remain bullish in the near-term (specifically through Q1) they are increasingly cautious as we head into the back end of the year. They see sovereign debt and inflation as potential hurdles to the continuation of the rally. After assessing all of the risks they came up with four potential outcomes for the market in 2010 and applied the probability of each:
Scenario 1 –This is the super bullish scenario. Stimulus continues to impact markets to near perfection. Reflation continues to work and money pours out of low risk assets and into high beta assets. Stimulus continues to pour into the system as the long-term repercussions of stimulus are ignored in favor of short-term gains. Rates stay low as a goldilocks scenario unfolds. Equities outperform and credit spreads continue to tighten.
Total equity returns: 34%
Scenario 2 –This scenario is characterized by a gradual easing in stimulus and easy money policies. As some momentum begins to grow in the first half of 2010 policy makers are comfortable beginning to tighten around the globe. In this scenario risk assets still outperform, but are muted by rising bond yields. Fixed income underperforms.
Total equity returns: 20%
Scenario 3 –Under this scenario bond yields spike sharply higher. The mountain of debt issuance and the end of quantitative easing programs fail to bolster the necessary demand. Inflation becomes a growing concern and the potential for sovereign debt problems increase. This is the Julian Robertson higher rates scenario. Equities and bond both perform poorly.
Total equity returns: -11%
Scenario 4 –This is the absolute nightmare scenario where deflation reasserts itself and a double dip becomes evident. The catalyst would be new banking scares, increased government regulation, sovereign debt scare, stimulus withdrawal. A flight to quality ensues and fears of 2008 become all too familiar. Stocks perform very poorly.
Total equity returns: -26%
Not surprisingly, scenario 2 is their most likely outcome. This is an outlook favored by most of the big banks. For the two contrarian banks we have previously covered please see MS Europes analysis and the Credit Suisse analysis.