Saxo Outlook 2009

8/14/2019 Saxo Outlook 2009

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OUTLOOK 2009TURBO-GLOOM AND ANNO HORRIBILIS



– OUTLOOK 2009 TURBO-GLOOM AND ANNO HORRIBILIS –

– 2 –

Welcome to our yearly outlook or the Global economy.

In 2009 Investors should prepare themselves or continued deleveraging, illiquidity, volatility and uncertainty.

The global nancial system has entered a new path towards the normalization o credit markets. We believe

that the last decade(s) o debt-nancing were anything but normal and that we will see signicant changes

in the perception o leverage and debt. Financial markets will have to adjust to the new paradigm, in which

leverage is seen more as a dangerous beast rather than an enhancer o prots. Growth will be negative across

the board, whether one looks at prot, real GDP, revenue or employment. In short, however much we wish

we were wrong, 2009 may prove to be an Anno Horribilis.




– 3 –

DAVID BAKKEGAARD KARSBØLCHIEF ECONOMIST

David Karsbøl is the head o the Saxo Bank Strategy Team and is responsible or

the overall macroeconomic views o Saxo Bank. He has a master’s degree in eco-

nomics (cand.polit.) rom the University o Copenhagen, where he specialised

in nance, statistics and monetary economics. His master’s thesis was about

the pricing o gold since 1971 and he is known or his contrarian thoughts.

He is available or comments on the macroeconomic situation and orecasts.

David Karsbøl concentrates on Business Cycle Analysis and subscribes to the

reasoning o the so-called Austrian School o Economics (Menger, Schumpeter,

von Mises, von Hayek etc.). He believes that understanding debt cycles is inte-

gral to understanding the general business cycle.

Ater having worked as an insurance analyst in Tryg A/S, he joined Saxo Bank

in 2003 to work under Steen Jakobsen, who is in charge o the bank’s hedge

unds programme. David Karsbøl worked as a macro strategist until he joined

the Strategy Team in 2005. He has headed the Strategy Team since summer,

2007.

STEEN JAKOBSENCHIEF INVESTMENT OFFICER

Steen Jakobsen is Saxo Bank’s chie investment ocer and a member o thebank’s Senior Management Group.

Mr. Jakobsen joined Saxo Bank in July 2000. He designs and manages Saxo

Bank’s current trading models and und management oerings or private and

institutional clients. In addition, Mr. Jakobsen runs the Saxo Macro und and

the Saxo FX und, totalling approximately $140 million in unds under manage-

ment.

Dividing his time between the London and Copenhagen oces, Mr. Jakobsen

has more than 20 years o experience within the elds o proprietary trading

and alternative investment. In 1989, ater nishing his studies in Economics

at Copenhagen University, he started his career at Citibank N.A. Copenhagen

rom where he moved to Hania Merchant Bank as Director, Head o Sales andOperations. Prior to joining Saxo Bank, Mr. Jakobsen worked or UBS in New

York as the Executive Director in the Global Proprietary Trading Group.




– 4 –

CHRISTIAN TEGLLUND BLAABJERGCHIEF EQUITY STRATEGIST

Christian Tegllund Blaabjerg grew up in Kolding, Denmark, and has a broadeducational background ranging rom a Mastersin Political Science rom Uni-

versity o Aarhus to a degree in nance rom ASB, Aarhus School o Business.

Prior to joining Saxo Bank in 2007 Christian was a quantitative analyst in Danish

company Novozymes A/S within sales and marketing.

Christian works with equity analysis both on single company and equity markets

level. His primary ocus is to develop trading models using various approaches

based on statistics/econometrics. Mr. Blaabjerg is available or comments on

major companies as well as equity markets in general.

Christian Tegllund Blaabjerg also appears regularly on major nancial news

networks and printed media, commenting on single stocks as well as stock

market developments.

JOHN HARDYCHIEF FX STRATEGIST

John Hardy graduated rom University o Texas at Austin (graduated with highhonours). John is Head o Forex Strategy or Saxo Bank. Originally rom Texas,

John has developed a broad ollowing rom his popular and oten quoted daily

Forex Market Update column, received by Saxo Bank clients and partners, the

press and sales traders.

John is a regular guest and commentator on television networks, including

CNBC, CNBC Arabia and Bloomberg. Outside o his column and media appear-

ances, John generates trading ideas to prot rom swings in the market on a

1-5 day time horizon.

He also writes regular ad-hoc commentary ocusing on the major currencies,

Central Bank policies, macro-economic trends and other developments and is

one o the authors o the Saxo Bank Yearly Outlooks and 10 Outrageous Pre-dictions. John has been with Saxo Bank or over six years.




– 5 –

ContentSAXO BANK’S OUTRAGEOUS PREDICTIONS FOR 2009 P 6

2009 TOP10 PICKS P 8

RECAPPING OUR 2008 PORTFOLIO P 10

PREMISES FOR THE YO2009: MAJOR CONTRACTION P 11

ENTER THE DARK HORSE, BERNANKE (JUST ANOTHER INFLATIONIST) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 12

CULTURAL CHANGE, BUT NOT THE ONE OBAMA PROMISED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 13

GROWTH PERSPECTIVES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 14

EQUITIES IN 2009 P 16

EARNINGS ESTIMATES FOR MARKETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 17

HOW MUCH IS ALREADY PRICED IN? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 18

WHAT CAN WE EXPECT FROM DIVIDENDS? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 19

VALUATION TARGETS FOR INDICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 20

TRADE RECOMMENDATIONS – SECTORS/SINGLE STOCKS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 22

COMMODITIES IN 2009 P 24

CHINA IN 2008 = UNITED STATES IN 1929? P 25

TOTAL WRITEDOWNS END-OF-CYCLE AND EVENTUAL SIGNS OF RECOVERY P 26

FX IN 2009: ANOTHER WHIPLASH REVERSAL AHEAD FOR THE USD? P 27

USD: ONE MORE ROUND OF STRENGTH - THEN GOODBYE GREENBACK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 28

EUR: SAFE HARBOR OR AN ACCIDENT WAITING TO HAPPEN? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 29

JPY: A ROCKY ROAD FOR 2009 AS JAPAN FIGHTS JPY STRENGTHENING PRESSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 30

GBP: MOST OF THE PAIN ALREADY PRICED IN? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 31

CHF: NO LONGER A SAFE HAVEN? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 31AUD: TO REMAIN DOWN UNDER? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 32

CAD: A HAS-BEEN UNTIL 2010? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 32

NZD: FURTHER TO FALL... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 32

NOK AND SEK: WORTH A LOOK IN 2009? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P. 33

ENERGY IN 2009: FALLING CRUDE PRICES A HUGE GEOPOLITICAL RISK P 34

TOP TEN REASONS TO STOP WORRYING ABOUT CLIMATE CHANGE P 36




– 6 –

SAXO BANK’S OUTRAGEOUS PREDICTIONS FOR 2009

True to the tradition, or 2009 we are oering our “10 Outrageous Claims”. The primary reason or doing this “Black

Swan” exercise every year is that human psychology is usually skewed towards optimism. Who would have thought that

the market capitalization o Citigroup would have gone rom $165B to $40B in less than a year? Or that Lehman would

go bankrupt? Or that the GSE’s would be taken over? We tend to be somewhat more pessimistic in our Yearly Outlooks

than the average analyst in the market and believe that it is important or the investor to always take into account the

less likely scenarios (as perceived by the market).

When the market is about to bottom out and risk willingness still seems to be longer away than ever, we hope to be

among the rst, small optimistic crowd in calling or higher levels. Please keep in mind that this is more o a thought exercise

than a set o outright predictions – we do not see that chances are better than 50-50 or all o these claims. However,

we believe that odds o these events are signicantly higher than what is currently priced‐into the market. In the past we

have had 3 or 4 out o 10 right, hopeully next year it will be less.

Iranian Revolution

The Iranian economy is already under pressure as it is. However the single most important export good is oil and since

we expect oil to trade as low as $40 or even $35, the purchasing power o the Iranian society in USD will diminish. The

government will be under severe pressure as they will not be able to uphold the supply o basic necessities. There are

limits as to how much the Iranian population will stand up to. These limits are wide in a well unctioning economy, but

with energy prices dropping heavily, social unrest and dissatisaction are guaranteed.

Crude @ 25 USD

Crude will trade lower during 2009 as the demand slows due to the worst, global economic contraction since the Great

Depression. We will see production cuts by OPEC, but due to disagreement within OPEC the cuts will not be as substantial

as required in order to hinder crude alling rom the current levels. Furthermore, oil producing and less civilized countries

that have grown dependent on oil revenues in order to please their populations will desperately break any concertedeorts to keep oil prices high.

S&P500 in 500

S&P500 will hit 500 in 2009. The primary reason will be alling earnings, rather than alling P/E ratios (since the low interest

rates justiy relatively high P/E’s). There are several reasons why earnings will continue to drop: 1) Consumers will no longer

be able to extent their credit rom banks, since they are writing o losses and need to lower their balances. 2) Cost o

unds have also increased in the corporate sector and especially or debt nanced consumption. 3) Total housing equity

is vaporizing and will no longer be able to serve as collateral or loans. 4) Companies will curb their investing programs,

which will hurt B2B business models.

Italy will make good on threats to leave the ERMItaly has a long‐run aection or devaluations, which is not possible within the single‐currency cooperation. Government

nances are under immense pressure and the ERM requirements will not only be violated, they will be completely ignored

in 2009. EU is likely to crack down on excessive government budget decits in several member states, but Italy could make

good on previous threats to leave the ERM completely.




– 7 –

AUDJPY to 40

The Australian economy is heavily infuenced by the commodity market and a large part o the country’s economic expansion

in the past year has been driven by the commodity boom. We believe that the whole commodity complex will be let dead

in the water or the next ten years due to real demand destruction caused by the high prices in the past ve years. At thesame time, we are bullish JPY with the big, Japanese Current Account Decit and the overwhelming domestic savings.

EURUSD to 0.95 – and then to 1.30

The potential problems in the Euro‐Zone are simply not getting the attention they deserve. European bank balances are

under tremendous pressure due to the out‐sized exposure to Eastern Europe – a region that will increasingly alter during

2009. At the same time intra‐European economic tensions are increasing as witnessed by the government bond spreads

vs. Bunds. Additionally, the USD is the primary medium o exchange in money markets, which ensures that as long as they

stay tight, USD demand will be high. That said, the USD isn’t a sound currency and the obvious problems in the Euro‐Zone

are very soon all priced in. Thus, a move to 0.95 will be undershooting the undamental case.

Chinese GDP growth to 0%This is as close to recession, China gets in 2009. The export driven sectors in the Chinese economy will be hurt signicantly

by the ree‐all economic activity in the US. Furthermore, a lot o the commodity based investments that have been

undertaken in the past ve years will sour with the collapsing commodity prices. Since the Chinese economy has been

stimulated by overly expansive monetary policy or years, more o the thereby induced speculative excesses will also be

revealed in 2009.

Pre In’s First Out

We believe that several o the Eastern European currencies currently pegged or semi‐pegged to the EUR will be under

increasing pressure due to capital outfows in 2009. Several o these countries already have extremely large Current

Account Decits and their needed renancing will make them vulnerable to additional credit market disruptions. This

especially goes or the Baltic currencies. At least one EE currency will be de-pegged (be rst out).

Reuters/Jeeries CRB Index to drop 30% (to 150)

Commodities might have been an even bigger bubble in the past years than equities (but not credit derivatives). We

believe that the speculative excesses have been so large that they have even skewed the demand and supply statistics.

We even doubt the consensus belie that demand has been outstripping supply or years is true. Hidden stockpiles o

especially industrial metals will be unloaded during 2009 and that will press prices even lower.

First Asian currency to be pegged to CNY

China’s economic, political and cultural infuence is growing and a return rom Phony Economics to Old School economics

will lead everyone to ocus at the important issues. In other words: Who has the productive potential? Who holds the

debt? Who has growth and savings? Most o the answers will avour China and the Asian economies will increasingly look

towards China to nd new trade partners and to scale down on the hitherto US‐centric agenda.




– 8 –

2009 TOP 10 PICKS

1) Short Nasdaq

The Iranian economy is already under pressure as it is. However the single most important export good is oil and since

we expect oil to trade as low as $40 or even $35, the purchasing power o the Iranian society in USD will diminish. The

government will be under severe pressure as they will not be able to uphold the supply o basic necessities. There are

limits as to how much the Iranian population will stand up to. These limits are wide in a well unctioning economy, but

with energy prices dropping heavily, social unrest and dissatisaction are guaranteed.

2) Play the “range” in EURUSD

Sell EURUSD at 1.65, Buy EURUSD at parity: Bernanke’s Fed has declared all-out war on defation by taking rates to 0%

and moving into alternative policy measures that are exploding the Fed’s balance sheet. On the other side o the pond,

Trichet and the Bundesbank conservatives are taking a tighter stance and warning o too much monetary easing. This dramatic

divergence in policy direction and philosophy will create tremendous volatility in EURUSD in the coming year. On the one

hand, the EUR strength is unsustainable and EUR is very vulnerable i we see a perect storm o economic weakness,

urther deleveraging and European banks getting pummelled by heavy Eastern Europe exposure, so we would be happy

to sell EUR i it approaches and exceeds 2008 highs. Yet we are also long term bears on the USD, so i we do get a wild

sell-o in the EUR, parity would oer an attractive buying opportunity with an eventual target o 1.2000 or higher.

3) Buy German Government Bonds: 4.25%, 7/4/2039

We are entering a phase o deleveraging and extremely illiquid debt markets. Many assets are being liquidated and we

expect commodities to be under considerable pressure throughout 2009. At the same time, investors will seek reuge in

government assets. Especially high-duration xed income like the German 4.25% 7/4/2039 oer an attractive sae haven

or investors as disinfation or outright defation will dominate nancial markets in 2009. Japanese government bonds per-

ormed extremely well the ten years rom 1990 where the Japanese stock and housing market bubbles burst. We believe

that the same will be the case now as the situation today is comparable to that o Japan in 1990-1991. I central banks

around the world decide to ght defation and help governments nance the ballooning budget decits, it might actuallyprove to be an important support or German bonds which are still yielding much more than the US comparables.

4) Short CEE Basket vs. EUR

Long EUR/CEE basket (CZK, PLZ, HUF). The three largest central European economies were the darlings among emerging

market economies during the go-go days o the global credit growth bubble. Huge capital infows set these economies

on re: xed asset investment boomed, credit expansion saw heavy borrowing at all levels. All three countries ran budget

decits due to cheap global nancing conditions. In the private sector, individuals took out mortgages in oreign currencies

like the Swiss Franc in what seemed a win-win situation – as major currencies were alling against the local currency and

interest rates were ar lower abroad. Now, the credit bubble is unwinding with vicious orce and these countries will be

hard pressed in the rebalancing act that must take place. Foreign debts are infating dangerously as the capital fow reversal

is rapidly devaluing these currencies. Credit has also dried up: or mortgage holders holding oreign loans who are at

increasing risk o deault and or the countries themselves, who will have to act quickly. The three major CEE currenciesmay all all sharply against the EUR in 2009.

5) Short AUD/G5 basket

Short AUD vs. G5 Basket (USD, JPY, CHF, EUR and GBP): AUD is the G-7 currency normally most closely allied with global

economic growth cycles and risk appetite. With our outlook or a very weak economic environment and signicant room

or urther deleveraging o risky assets, we would expect the already rather weak AUD to all even urther in 2009. This

is also a way to express a little extra downside risk in case the situation in China gets even uglier than the market expects

– something we expect has a reasonably high possibility o occurring. AUD will also be hard pressed on any signicant

defation in its iron ore and coal exports to mainland Asia.




– 9 –

As well, Australian consumers are some o the most overleveraged in the world, and as the recession moves rom the

nancial world to the consumer, Australia seems particularly poorly positioned or urther weakness. The ormer premium

that AUD enjoyed due to its high interest rates will rapidly disappear as the central banks continues to cut deeply in the

New Year.

6) Short Copper

As an important building material and industrial input, copper is sensitive to the business cycle. With a rapid and unprecedented

contraction o economic activity, demand or copper has collapsed. And yet, the price o copper has still only allen to

the 2005 level (around 150). According to our estimates, marginal costs o production or the majority o the industry

is around 70 cents per pound. We believe that the very high commodity prices in the past years have let to real demand

destruction – i.e. permanent substitution and alternative inputs in industry. That is part o the reason or the collapsing

demand. Another reason might be hitherto hidden, speculative stockpiles that distorted supply/demand statistics and led

everybody to believe that demand was outstripping supply or years. We now question this perception and believe that

these stockpiles are being dumped on the market… leading to prices that might actually undershoot the marginal costs

o production.

7) Buy PIO (PowerShares Global Water Portolio)

Scores o countries are overpumping aquiers as they struggle to satisy their growing water needs. The drilling o millions

o irrigation wells has pushed water withdrawals beyond recharge rates, in eect leading to groundwater mining. The

ailure o governments to limit pumping to the sustainable yield o aquiers means that water tables are now alling in

countries that contain more than hal the world’s people, including the big three grain producers—China, India, and the

United States. We do not see that these acts are priced into water stocks yet and recommend buying the EFT Powershare

Global Water Portolio (PIO).

8) Buy S&P500 @ 500

Our macroeconomic scenario is disinfation and in such scenario companies will experience lower sales. Due to relative

high operational leverage margins will be hit severely; we expect margins to contract by 20% on average or S&P500

companies leading to an expectation o an earnings growth o -30% or S&P500. Depending on the valuation technique

used and assumptions made prior to the analysis we estimate the low or S&P500 in the range o 600-650 in 2009.

However bear markets tend to undershoot especially when prior bull markets overshot. The overshooting in the last bull

market was the biggest ever so 500 in S&P500 seems very likely. However, we also believe that we will see a slow rebound

starting in the end o 2009 and with S&P500 in 500 valuations starts to look very attractive indeed. We will be buyers at

these levels.

9) Short Valeo

Valeo is a subcontractor to the car makers producing parts. Valeo operates with a very high operating leverage and low

operating margin (EBIT) at 4% expected or 2008. With consumers hitting the brakes and car sales expected to drop like a

stone across the world during 2009 Valeo will suer rom this. A lower sales will turn earnings negative and the negative

earnings will put pressure on the dividend payout. The current very high dividend payout ratio will most likely go lower

and this will make the share trade lower and outperorm the market to downside.

10) Short TUI Travel

TUI Travel is an operator o an international travel and leisure group. As the economy contracts, consumers cut back

on spending. One o the rst things to cut back on is the spending on travel and leisure as this is not an ingredient in

the daily operation o a household. We expect the demand or travel and leisure will drop during 2009 as the economy

contracts urther. The average operating leverage or the travel and leisure sector is 1.39, which is quite high given their

low margins at 7%. However TUI Travels operating margin is already negative at -0.71% and with a lower expected sales

earnings will turn negative. Dividends will be cut and the share will drop aster than the general market.




– 10 –

RECAPPING OUR 2008 PORTFOLIO

On the back o the ongoing credit crisis, our 2008 portolio was based on the expectation o a worldwide recession.

Among our Top 10 Picks was a ocus on a deteriorating US housing market and transport sector and an overheated Icelandic

economy among other things. The perormance o our 2008 portolio refects the act that it has been a very dicult year

in which to navigate the global nancial markets. Our FX picks returned (12,7%) ater being up by 21,5% dur ing the year,

proting rom being long TRYISK, EURHUF and short GBPCHF. However, though naming 2008 “The Year o Recession”,

even we were surprised by the magnitude o the global slowdown. A ew o our equity picks were based on ever higher

commodity prices, but we ound to the detriment o the portolio that alling global demand saw these trades turn rom

winners to losers. Our portolio was up by 21.5% by end-June, but ended the year down (3.7%).

20%

10%

0%

15%

5%

-5%

2008 PORTFOLIO, USD DENOMINATED

-10% j a n- 0 8

a pr - 0 8

j ul - 0 8

ok t - 0 8

f e b - 0 8

m a j - 0 8

a u g- 0 8

n ov - 0 8

m a r - 0 8

j un- 0 8

s e p- 0 8

d e c - 0 8




– 11 –

PREMISES FOR THE YO2009: MAJOR CONTRACTION

Last year, we wrote in the YO2008 that we are about to witness a change in a megatrend that has lasted almost 30 years.

In our eyes, 1980 marks the beginning o this trend, which has had debt-nancing and credit creation as its hallmark. In

short, every economic problem was met with lower rates and yet more plentiul credit to the nancial system.

Our thesis was that the easy credit ostered a speculative boom unprecedented in human history and that asset prices

were getting so much out o sync with reality that even the commercial banking system, which was the channel o credit

to the real economy, no longer wanted to increase lending. The act that central banks began cutting rates aggressively

by the end o 2007 and that money markets did not react by letting interbank market rates drop as well was a clear sign

that the nancial system was saturated with risk.

To be honest, we have been negative on the whole recovery since 2003 (just read our Outlooks rom 2004 and onwards).

Our take was that we never really got a thorough clean up o the nancial system back then and that the low-rate environment

just led to speculative excesses that were even worse than the dot-com bubble. We were denitely among the most

bearish on stocks in our YO2008 (calling S&P500 25% lower and the Shanghai Composite 40% lower during the year).

Events during 2008 proved that our thesis was more than right. Actually, we have been surprised and rightened about

the speed o the deleveraging.

The year 2008 proved us right and we will stick to our thesis or 2009: deleveraging will continue and get really, really

ugly. Make no mistake; this is a bubble comparable in size to the one that burst in 1929. Actually, measured by the outstanding

credit to GDP ratio in the US, the bubble that is now beginning to defate is around twice as big now (350%) as in 1929

(170%).

That means that there is no escape: Assets stand in ront o an enormous, defationary pressure. The only asset class that will

survive in the next year or two is government bonds, but even these will be threatened by the hyperinfation that is likely to

result rom the exploding money supplies around the world.

All central bankers are subscribing to some variant o Keynesianism (whether they call themselves Monetarists or not) and want

to lower interest rates in order to avoid defation. Thus, central banks will continue to lower rates throughout 2009 as economic

activity and consumer prices reach or new lows. They are probably already in despair over their lack o ability to alleviate the

eects o altering asset prices. Lending has come to a total stand-still, which has until now only been possible in their worst

nightmares.

Source: Bloomberg, Saxo Bank.

20%

10%

0%

15%

5%

-5%

US: TOTAL OUTSTANDING CREDIT / NOMINAL GDP

1 9 2 3

1 9 2 6

1 9 2 8

1 9 3 1

1 9 3 4

1 9 3 7

1 9 3 9

1 9 4 2

1 9 4 5

1 9 4 8

1 9 5 0

1 9 5 3

1 9 5 6

1 9 5 9

1 9 6 1

1 9 6 4

1 9 6 7

1 9 7 0

1 9 7 2

1 9 7 5

1 9 7 8

1 9 8 1

1 9 8 3

1 9 8 6

1 9 8 9

1 9 9 2

1 9 9 4

1 9 9 7

2 0 0 0

2 0 0 3

2 0 0 5

2 0 0 8




– 12 –

ENTER THE DARK HORSE, BERNANKE (JUST ANOTHER INFLATIONIST)

Ben Bernanke was chosen as Fed Chairman due to his alleged expertise as a defation/depression ghter. He is assumed

to be “unconventional” in his ways o addressing the current nancial calamities. Until now, his monetary policy hasbeen undistinguishable rom that o any other central banker that has bought into the Milton Friedman or John Maynard

Keynes doctrines. However, 2009 will be the year that proves whether he is really unconventional or not. We believe that

Bernanke will lead the pack o central bankers on the march towards ultraexpansive monetary policy. We are not only

talking about plain vanilla lowering o interest rates here – In a eeble attempt to stop defation, central banks will see

themselves orced into outright monetization o all kinds o assets. In other words, printing presses will go rom rantic

high-speed to insane overdrive. A number o things are likely to be tried by desperate central bankers and authorities in

order to avoid defationary pressures:

1. Government xed income will be bought (monetized) or two reasons. A) First o all in order to help government

nance massive stimulus eorts so politicians are seen as “doing something” about the problem. B) Second, in order to

bring down the long end o the yield curve so nancing costs are lower or altering equity markets. Both the Euro-Zone

and the US have weak public nances, but the Euro-Zone have legal and political requirements or the participation inthe European Monetary Union that stand in the way o monetization o public debt. These requirements may quickly be

revised or the alleged benet o public spending and “stimulus”, but especially the US will be prone to monetize public

debt. We believe that in order to stimulate the ree-all economy, the Obama administration will cut taxes and cover the

exploding budget decit with reshly printed money.

2. When it becomes apparent that the commercial banking system does not want to pass on the credit made available by

the central banks to consumers and corporations (and 1-B thereore ails), central banks and governments will indirectly

increasingly act as a commercial lender in stead o the commercial banking system. This will happen with increased regulation

and subsidies etc. to encourage banks to lend and “unreeze” the debt markets.

3. When mortgage bond and corporate bond spreads are continuing to widen and 1 and 2 have both ailed or not provedsucient, central banks and governments will begin to simply monetize mortgage bonds and corporate bond to bring

down rates and “stimulate” the economy.

4. Accounting standards will be revised in order to stop mark-to-market induced sell-os. Models will be allowed to

price the troubled and illiquid assets (CDO’s, CLO’s, MBS’s and LBO bonds etc.). The problem is that the nancial system

is unwinding at such a rapid pace and with such erocious power that the collateral behind these assets will continue to

deteriorate. In other words, phony accounting standards will not save the holders o these troubled assets rom deaulting

counterparties and adverse market conditions.




– 13 –

CULTURAL CHANGE, BUT NOT THE ONE OBAMA PROMISED

President elect, Barack Obama, has talked a lot about “Change”. There is no doubt that change is coming. In the Yearly

Outlook or 2008, we expected a turnaround in the megatrend o widespread debt-nancing culture. Debt has becomeso big that the costs o servicing it are crowding out the consumption needed to maintain the investments. That is why

the whole Ponzi-scheme is now unravelling. There is no doubt that we are already seeing the rst changes and reckoning

that change has come. No investors can assume any longer that they can just go to their bank and ask or more money

at low rates. No bank can assume any longer that it can lend out endless amounts o money without any credit risk. No

business can assume any longer that it can issue more corporate debt at Libor +100 bps.

Cultural change is coming in how economic aairs are being perceived. Shareholder equity will have to increase and internal

growth will be dominant vs. debt-nanced growth in businesses. Dividend yields will be a new and important indicator

or the cash-fow strength o stocks. Culture will change rom “we don’t pay a dividend, because we believe too much in

our own business” to “we do pay a dividend, because we have the cash-fow to support it”.



GROWTH PERSPECTIVES

The world economy is experiencing the worst contract ion since the early 1980’s. In all o 2008, economic activity has been

in ree all, and we believe the same will be the case or 2009. Our Global Business Cycle Indicator is showing the worstand most rapid drop in its history (see graph below).

Since the current recession is worse and bigger in magnitude – both rom a geographical and an asset class perspective

– we believe that our indicator can continue to edge lower during 2009, albeit at a lower pace than previously. Like in1992-93, we will probably see two or three years with lower and lower economic activity.

A lot o countries have already gone into recession – either de acto or according to the technical denition (two con-

secutive quarters o GDP contraction). Their numbers will increase and global trade fows will contract as more and more

consumers cut even deeper into consumption than they have already done.

We believe that the majority o countries in the world will experience a recession in 2009. Because the current crisis has

nance as its root, especially countries with large current account decits will experience nancial problems and will be

likely deault candidates in 2009. In particular, we are keeping an eye on the Baltic states and Eastern Europe and expect

severe and deep recessions in these, but also oil-revenue dependent states like Russia, Venezuela and Iran will be very

vulnerable.


– 14 –

2,0%

1,0%

0,0%

1,5%

0,5%

-0,5%

SAXO BANK GLOBAL BUSINESS CYCLE INDICATOR

-2,0%

-1,5%

-1,0%

j u l - 8 5

j u l - 8 6

j u l - 8 7

j u l - 8 8

j u l - 8 9

j u l - 9 0

j u l - 9 1

j u l - 9 2

j u l - 9 3

j u l - 9 4

j u l - 9 5

j u l - 9 6

j u l - 9 7

j u l - 9 8

j u l - 9 9

j u l - 0 0

j u l - 0 1

j u l - 0 2

j u l - 0 3

j u l - 0 4

j u l - 0 5

j u l - 0 6

j u l - 0 7

j u l - 0 8




– 15 –

INTEREST RATES IN 2009: DEFLATION OR INFLATION?

There is no doubt in our minds: policy rates will head lower and in some countries considerably lower in 2009. Some

countries like the UK are now openly talking about adopting a Zero Interest Rate Policy (ZIRP) like Japan adopted ater thebubble burst in 1990. The ECB and SNB will also be orced to move rates much lower as Eastern Europe implodes due to

an inability to renance their borrowings.

But the really, really big question these days is: Will we have defation or infation? To answer the question, one has to

understand our monetary system. In previous times with gold convertibility and limits to the growth o the money supply,

one would expect severe defation as capital was destroyed and the real price o debt exploded. This time, however, there

are no limits whatsoever to the growth o the money supply. In the US, the M1 Money Supply has already exploded by

a staggering 10% ater having been virtually fat or 4 years. All across the globe, central banks will do the same: print

and spend money. We believe that 2009 will be a year o defation, but that exploding money supplies will prevent prices

alling or very long and lead to infation by 2010.

RISK VS. SAFE HAVEN: SPREADS TO EXPLODE

This, however, will only be the case or more developed countries with secure property rights and a sae haven status.

Other countries in Emerging Markets or with unsustainable current account decits will not be able to cut interest rates

rom here. Actually, EM countries might have to hike rates to attract capital or to just prevent large outfows. In other

words, despite risk premiums already at record highs, we will see them go even wider rom here. Spreads between corporate

and government xed income, between EM and G10, between long maturity and short maturity xed income, between

AAA vs. Junk will continue to widen.

THE LONG END OF THE CURVESince the world economy is experiencing the worst economic contraction in several decades – i not ever – tremendous

defationary pressures are gathering. Yes, central banks will print money like never beore, but we don’t believe they

will be able to overcome the defationary pressures in 2009 (usually there is around a 9 months lag between changes in

monetary policy and eects on the real economy and prices). Perhaps they will by 2010, but or the rst hal o 2009,

government xed income should outperorm every other type o asset. From H2-2009, however we will see the spread

between the US 10-year and the 2-year treasuries begin a long journey higher. The government bond market is the last

bubble that needs to burst and the “2-10 spread” will refect that this reckoning is dawning on the xed income market

during the second hal o 2009.




– 16 –

EQUITIES IN 2009

With a shrinking global economy and several economies in a disinfationary or outright disinfationary state it is very hard

to make a bullish case or equity markets. Historical evidence on equity perormance in times o disinfation is very clear

and very negative. During the early 1930’s the U.S. stock market delivered its worst returns o the past century. From the

peak to the through the S&P500 ell 84% in nominal terms. For Japan during the 1990’s the evidence is clearly better,

however still rather gloomy, losing 65% over a decade. In other words: Equities as an asset class are best avoided or short

sold in an economy where disinfation rules.

We expect global equity markets to hit lower lows during 1H 2009, beore a possible rebound during 2H 2009. This is our

best guess, but events could certainly unold dierently i a signicant bear market rally materializes early in 1H 2009 on

the back o oversold equity markets here in late 2008 and then the sell-o arrives later in 2H 2009 on urther negative

earnings revisions and disappointing recovery aspects or 2010. Either way, we expect signicant new lows or global

equities in 2009.

From the equity markets in the U.S. we expect in 2009 a total return o -15.5% composed by -17% in capital gains and

1.5% in dividend yields, while or Europe we expect a total return o -17.9%made up o -20% in capital gains and 2.1%

in dividend yields. Finally or Japan we expect the total return rom the equity markets o -19.9% coming rom -21%

in capital gains and 1.1% rom dividend yields. This is not particularly attractive especially compared with government

bonds like bunds with long maturity which currently yields 3.5%. When adding the downside risk or equities in 2009 the

comparison looks even worse or equities.

The global credit crunch has already had a signicant negative impact on corporate prots and the downgrading o

earnings expectations has been going on or a while. But despite valuations looking increasingly attractive we expect

more earnings downgrades are to come. In Europe we expect a 36% decline in 2009 earnings or the market excluding

nancials and an average 28% decline in EBIT margins. For the U.S. and Japan we expect a decline o 30% and 41% or

markets excluding nancials respectively and 20% and 35% decline in EBIT margins.

The good news is that equity markets have already priced in a severe earnings recession. Most measures, whether basedon prospective, historical or cyclically adjusted P/E’s say that equities are currently undervalued or at air value. But history

provides no meaningul reerence point when considering the current credit crunch. At current levels equities are not

attractive and there is still considerable downside risk or equities. Bear markets do tend to undershoot signicantly when

correcting downwards given that also the preceding upside overshoot was signicant in size. The last overshoot in equity

markets was the largest ever.




– 17 –

EARNINGS ESTIMATES FOR MARKETS

Forecasting earnings or 2009 is a nearly impossible task. The probabilities attached to dierent macro economic scenarios

tends to shit almost daily as new scal and monetary measures are announced or old ones changed in response to chang-

ing political environments. However in such periods o turmoil it is even more important to stick to the big picture that

drives equities: Future earnings and the valuation o these earnings. In this section we will address the rst o these issues,

while coming back to the second in the next section.

First, we nd it too early to turn bullish in anticipation o a turnaround in the global economy. Historically equities have

rallied 4-6 months prior to an economic turnaround. But our economics team does not oresee such a turnaround in the

global economy beore early/mid 2010. In such scenario late 2009 do seem like a more realistic time to turn bullish on

equities. Our earnings orecast or Europe, the US and Japan is shown in the table below.

Figure 1: Sales, EBIT Margin and Earnings Estimates (ex. nancials) or 2009.

Source: Thomson DataStream, Saxo Bank Research

We have intentionally excluded nancials as their earnings are heavily distorted by write downs and bailout packages rom

governments. In total their inclusion would disturb orecasts or the overall market.

The earnings orecasts assume negative sales or all markets which combined with disinfation results in an accelerated

negative top line growth. Such orecasts may not sound bearish enough to justiy the rather signicant drop in prots.

But operational leverage is important to keep in mind as anything below a 2% top line growth turns a margin boost into

a margin drop.

At the heart o our 2009 earnings growth orecast lays an assumption o negative sales or all three countries. The key to

this is clearly our outlook or a recession and thus negative real GDP growth. The latter drives sales growth or the corporate

sector. Our economics team orecast -1.5% growth in the Euro-Zone, -2% in Japan and -1.5% in the US.

Costs will most likely outgrow sales next year leading to the rst market-wide margin contraction since the last recession.

Wage infation is showing no signs o deceleration and should only subside with a considerable time lag as economic

activity slows. Our assumptions lead to EBIT margin contraction in the range o 20%-35%. Using these assumptions we

arrive at an earnings growth orecast or 2009 o -36% or the DJ STOXX 600, -30% or S&P500 and -41% or Nikkei225

– all ex. Financials.

Sales -5% -4% -6%

Europe US Japan

-28% -20% -35%

-36% -30% -41%

EBIT margin

Expected Earnings Growth(ex. Financials)




– 18 –

HOW MUCH IS ALREADY PRICED IN?

The good news is that much o the coming earnings decline is already a part o the current share prices; but as always the

real interesting question is how much? We are not able to derive an exact answer, but we can get a really good estimateby comparing current valuations with normalized valuations or the markets.

One approach in answering this question is using the P/E ratio. In order to analytically separate actors rom each other

it is useul to rewrite Gordon’s growth model to: P/E = Payout Ratio (D/E) / Risk premium. We have lately been witnessing

a alling P/E ratio and a part o this de-rating has been caused by the increased risk aversion in the market leading to

investors demanding a higher risk premium or holding equities. Another explanation o the de-rating is that investors are

cutting their earnings expectations.

In order to arrive with an estimate o how much o the expected earnings decline that are a part o the current shares

prices we calculated an average bear market P/E ater which we derived the 12 month orward P/E ex. nancials or each

o the markets. The result is shown in the table below.

Figure 2: Premium/Discount to Normal Bear Market P/E’s.

Europe has currently priced in a 20% decline, which is ar rom the 36% decline we expect. The picture or the US is pretty

much the same as in Europe in the sense that there is still some way to travel beore our estimated earnings growth decl ine

is priced in and the same goes or Japan. Given that our earnings orecast are correct we expect to see a signicant decline

in equity markets as the earnings decline is not yet ully priced in.

Source: Bloomberg, Thomson DataStream, Saxo Bank Research

Normal bear marketP/E (ex. Financials)

11 11 19

Europe US Japan

9 10 15

-20% -9% -21%

12 month orwardP/E (ex. Financials)

Premium/-Discount tonormalized bear market P/E




– 19 –

WHAT CAN WE EXPECT FROM DIVIDENDS?

As we have seen rom the previous sections earnings are under pressure and obviously the next question is what this will

mean or the uture dividend payments. Dividend payments have been much less volatile on the downside than earnings.In the last two recessions o 1991 and 2001 earnings dropped by an average o 50%, whereas dividends proved relatively

resilient and were only cut by on average by 6% or the European equity market.

Several companies and sectors are very much exposed to risks o cuts ollowing rom their lower earnings. The most

obvious example are nancials, where solvency concerns, capital increases and part-nationalizations are causing sharp

reductions to uture dividend payments; in many cases no dividends will be paid at all through 2010. Banks have been

the largest contributor to the total market dividend payouts and with this source o yields disappearing we expect to see

a lower level o dividends at the aggregated level.

Assuming that the payout ratio will be lowered ollowing rom the 50% average payout in bull markets to a 30% payout

ratio in bear markets we can derive the expected dividend yield which is shown in the table below.

Figure 3: Expected Dividend Yield or 2009.

Source: Thomson DataStream, Saxo Bank Research

Expected Dividend Yield 2.1% 1.5% 1.1%

Europe US Japan



VALUATION TARGETS FOR INDICES

Equities, whether American, European or Japanese look cheap on most measures when compared with recent history. The

problem with recent history is that it is next to meaningless in the current economic situation. Thereore it is more useulto look at long-term valuation indicators which include periods o infation, recession, disinfation or even depression.

The 100-year valuation history o the US equity market provides a useul benchmark. Although the correlation between

European, Japanese and US equities are not perect, it is unlikely that the markets will diverge signicantly in a globalised

world. The ollowing chart shows the US CAPE (cyclically adjusted market P/E) based on 10-year trailing EPS.

Figure 4: S&P500 CAPE (cyclically adjusted P/E) based on 10-year trailing EPS (1881-2008)

Source: Pro. Shiller, Saxo Bank Research


– 20 –

The message rom the chart is not reassuring. US equities have nally touched the long term mean, but history shows that

bear markets usually overshoot on the downside. The current CAPE o around 16x is still well above the levels seen at the

end o the previous secular bear market, such as in 1921, 1932, 1974 or in 1982.

Where does this leave European and Japanese equities? The European CAPE based on 10-year trailing EPS is still at 25x,

well above the 10-year US CAPE o 16x. The story is the same with the Japanese CAPE based on 5-year trailing EPS reading

28x also well above the US CAPE. The European and Japanese CAPE’s do imply that there is more value to be picked up

in the US equity market compared to the European and Japanese equity markets.

40

25

20Average = 16x

45

50

30

35

15

0

5

10

1 8 8 1

1 8 8 4

1 8 8 8

1 8 9 2

1 8 9 6

1 9 0 0

1 9 0 4

1 9 0 7

1 9 1 1

1 9 1 5

1 9 1 9

1 9 2 3

1 9 2 7

1 9 3 0

1 9 3 4

1 9 3 8

1 9 4 2

1 9 4 6

1 9 5 0

1 9 5 3

1 9 5 7

1 9 6 1

1 9 6 5

1 9 6 9

1 9 7 3

1 9 7 6

1 9 8 0

1 9 8 4

1 9 8 8

1 9 9 2

1 9 9 6

1 9 9 9

2 0 0 3

2 0 0 7




– 21 –

Given that CAPE is a poor timing tool and does not take into account uture growth rates and the cost o capital, it is

worth considering valuation measures which do. One o them is dividend discount model (DDM). The DDMs are highly

sensitive to the discount rate and growth assumptions used and should be used with care in the current volatile environment.

However the DDM approach is useul to p lace the current market into some context as well as oer some guide regardingfoor levels. Our assumptions are that earnings all in Europe by 36%, in the US by 30% and in Japan by 41%. Further-

more we are assuming that infation is 0 in 2009 and increasing slowly aterwards, the bond yield is 2%, the equity risk

premium is at 5% and we expect a 2% real growth in earnings. The results are displayed on the next page.

Figure 5: Equity Index Targets based on DDM simulations.

This gloomy outlook results in that the DJ Stoxx600 will retreat 35% rom current levels (as o 19. Dec. 2008), the S&P500

will drop 31% and Nikkei225 will trade 38% lower. We these decline prices in mind we do not recommend entering

naked long positions in the equity market beore the market has turned, which we expect will happen late 2009 as previously

mentioned.

Source: Bloomberg, Saxo Bank Research

DJ Stoxx600

S&P500

Nikkei225

197

885

8667

130

610

5350

19. Dec. 2008 Lows 2009 based on DDM valuation




– 22 –

TRADE RECOMMENDATIONS – SECTORS/SINGLE STOCKS

Financial gearing should is an important criterion in stock selection and sector allocation when we enter disinfation. Any

debt is bad debt, so those companies with high nancial gearing ratios would see interest expenses drain earnings and insome cases could struggle to meet interest payments as prots all sharply. Highly geared cyclical sectors look most risky.

Here, the risk o earnings alling sharply is severe as we enter disinfation and an economic recession make high debt levels

particularly dicult to justiy and maintain.

The second characteristic that is best avoided in a disinfationary environment is exposure to the investment cycle. As explained

earlier, disinfation creates a vicious circle and discourages companies rom investing. Falling prices give consumers an

incentive to delay purchases and companies and incentive to delay investments. This behavior causes prices to all even

urther, starting the process all over again. Government spending is the third criteria. The advantage o exposure to

government spending is that it tends to be much less volatile and oten counter-cyclical. Even though we are still ar away

rom the circumstances o the Great Depression politicians across the world have already foated ideas o government

spending to preserve jobs and jumpstart the economy.

The nal characteristic that is best avoided in a disinfationary environment is operational leverage especially combinedwith low margins. With alling price levels oten accompanied by similar weakness sales volumes top lines are likely to

come under pressure in a disinfationary environment. As a result many companies are likely to struggle to deliver the sales

growth rates needed to maintain margins. We have scored each sector according to their criteria above using -1, 0 or 1

depending on whether how they perorm. Our point o departure is that we are looking or sectors that are best hedged

against disinfation assuming that we are in a long position. So i the sector is hedged against infation it will receive a

score o +1, less good a 0 and i bad it will be given the score -1. Even though we are dealing with three dierent stock

markets we have chosen to rank the sectors across markets. This is due to the general nature o the criteria. The results

are shown in the table below.

Figure 6: Ranking o Expected Sector Perormance in a Disinfationary Environment

Source: Saxo Bank Research

Cons. Disc.

Cons. Staples

Energy

Financials

Health care

Industrials

Ino. Technology

Materials

Telecom

Utilities

-1

0

-1

0

+1

-1

-1

0

0

-1

-1

+1

-1

-1

+1

-1

-1

-1

+1

+1

0

0

0

0

+1

+1

0

0

0

0

-1

+1

+1

+1

+1

-1

0

-1

+1

+1

-3

2

-1

0

4

-2

-2

-2

2

1

Sector Cyclical vs.Non-cyclical Operational lev.+ low marginsFinancial leverage Governmentexposure Total Score




– 23 –

I the sector receives a score between -4 and -1 we expect the sector to underperorm compared to general market.

I the sector gets a score o 0 we are neutral and i the sector gets a score between 1 and 4 we expect the sector will

outperorm the general market. In other words we expect sectors like consumer d iscretionary, energy, industrials, materials

and inormation technology to underperorm the general market. We are neutral on nancials and expect health care,consumer staples, telecom and utilities to outperorm the general market.

Since we are rather bearish on equities or 2009 we recommend staying short in equities until the equity market has

rebounded in 2009. We have applied the same criteria or single stock picks and have only chosen stocks with a score

o -3 to -4 in order to enter short positions. We recommend entering short positions in the ollowing stocks: Valeo

(Consumer Discretionary), TUI Travel (Consumer Discretionary), OMV (Energy), Kuehne + Nagel (Industrials), Sage Group

(Inormation Technology).



COMMODITIES IN 2009

Several actors have been causing commodities to collapse in the second hal o 2008. We expect these actors to continue

depressing commodities throughout 2009.

First o all, USD strength was a huge actor, as most commodities trade in USD terms. At least a th o the 60% decline

should be seen in this light.

Second, there is no doubt that a very big, speculative element has entered this market – mutual, pension and hedge unds

have all ound commodities to be a new element, which would they believed would enable them to decrease the volatility

o their returns. By using utures contracts, they believed that they could both capture the “roll yield” (rom the general

contango in the market and at the same time reduce overall portolio risk. The problem has obviously been that 1) too

many did it at the same time so that the commodity markets went into massive backwardation and 2) since everybody

bought commodities to reduce the portolio risk stemming rom stock markets, the correlation went to 1 anyway – and

especially so when commodity prices ell across the board in H2-2008.

Third, ater scrutinizing supply and demand statistics, especially or the, we believe that ocial data has been manipulated in

order to scare the demand side into panic buying. The emergence o unds with the sole purpose o investing in physical metal

itsel has taken some o the physical metal o the “data table”, skewing the statistics to show that estimated demand

was outstripping supply. Thus, hidden stockpiles seem to have been built during the past our or ve year and these positions

now seem to be getting dumped on the market.

As ater previous commodity bull markets, we are now entering a decade where very high prices have destroyed demand

or a decade (at least). Aggregate demand is dropping and where demand is still intact, substitution is setting in or key

industries. Even or Crude Oil, we are now seeing the total mileage driven in the US – a measure previously thought to be

completely inelastic - dropping or the rst time in at least 50 years. With a severe slowdown in China, aggregate commodity

consumption is set to show outright decline in 2009.

We expect all industrial metals to continue heading lower or 2009. Gold is likely to outperorm silver, since the latter alsohas an industrial use and since gold is generally perceived as a better and more traditional hedge against turmoil, infation

and devaluation (o the USD). Costs will be reduced in the whole commodity complex and prices on the commodities

might actually undershoot marginal costs o production. Overall, that probably means that base metals could drop by

roughly 50% rom current levels. Look or copper to drop below 70 cents per pound and zinc to drop to $600 per ton.

Commodity shares will continue to get creamed in 2009. Many have expanded investments dramatically in response to

higher prices. High, xed costs and in many instances outright negative margins will lead to operations being closed down

and many going bankrupt (see more in the Equity section o the publication).


– 24 –



CHINA IN 2008 = UNITED STATES IN 1929?

China, China, China. China has been THE story in the past ve years. Who would not be invested in a country with

minimum 10% growth per year, with a strongly growing consumption (at least sometime in the uture), thousands and

thousands o new millionaires and a voracious appetite or commodities? Everyone has depended on China – both to get

a return and to explain how global growth could and would continue. Everyone wanted to go there, either physically or

by investing.

Well, isn’t this exactly how investors perceived the United States in 1929 (albeit US growth was only averaging 4% p.a.

beore 1929, but it was still somewhat higher than in the rest o the world)? There are more parallels: Both China and

the US in 1929 experienced extremely strong growth rates (roaring twenties in the US) or almost a decade, which com-

pletely blinded observers. Both have had some o the world’s highest savings and investment rates in their boom periods.

Both had signicant current account surpluses to cope with (China by buying US Treasuries, the US by buying gold). Both

were trying to uphold pegs to altering and unsound assets: The US tried to prop up the GBP at a ridiculous rate ater the

re-peg to gold caused by WWI infation and China is now trying to peg to the USD, which despite the newound strength

is still trending lower and will end in catastrophe.

For both o the countries and their boom periods, monetary policy was extremely expansive at the same time as the general

price levels were fat to only moderately increasing, which led observers to erroneously conclude that monetary policy was

“neutral”. Thereore, very big bubbles were allowed to evolve and burst.

In the 1930’s, the US was one o the economies worst hit by the crisis, because their monetary policy was taken to the

arthest extremes. Chinese monetary policy has consistently been most extreme among the G20 countries. Over the past

10 years, annual M2 Money Supply growth in China has averaged +16%. That should be very rightening or the eternal

China bulls. To us, China looks like a very big bubble. The whole economy has become way too dependent on debt-

nanced US consumption, which has now come to an abrupt halt. And the Chinese don’t have any plan B.

China is already now, in 2008, closing down thousands o actories, which paid migrant workers rom the rural areas a

wage almost three times higher than the one they could make in the countryside. This will continue in 2009 as exportsare collapsing. Like in the nal years o the Roman Empire, the population will actually seek towards the countryside in

order to be able to eed itsel. The division o labor is alling apart and China will probably go through one o the worst

transition periods among all economies. The big question is i the mixed economy nancial system will be a cushion or

the Chinese economy or a drag. The need or fexibility is indicating that it will be a drag.

Although government will make massive investments in inrastructure, they will be lucky to see positive growth in the

next two years. As we indicate in the equity section, we will probably not recommend buying stocks in 2009 and Chinese

stocks are denitely among the least likely candidates i we do.


– 25 –



TOTAL WRITEDOWNS END-OF-CYCLEAND EVENTUAL SIGNS OF RECOVERY

At the end o 2008, total credit writedowns stood at around $700 billion, the majority o which originated in the US

(70%). Ater revisions, we will probably end at $750 billion or the whole year. Total, global writedowns since Q2-2007

now stand at almost $1 trillion. We have previously expressed that we anticipated a total o $2 trillion, but have now come

to the conclusion that $2.5 trillion or even $3 trillion is more likely beore this crisis is over.

This estimate is based on a top-down analysis o historical experiences in recessions with deault rates, the ratio o

outstanding debt to GDP and recovery rates. With commercial mortgages worth almost $1 trillion, junk bonds and LBO’s

at $3 trillion, prime mortgages o $8 trillion, consumer loans and home equity loans o $2 trillion and subprime and non-rst

home mortgages totalling another $3 trillion, we are seeing a total o $17 trillion o assets that are at various risks o

deaulting. A lot o these assets are tightly collateralized by the housing market, which means that an additional downside

o 15-20% in home prices will lead to widespread insolvency.

Subprime mortgages have been blamed or the writedown losses, but the problem is much more undamental and widespread.

Now, 7% o all mortgages are delinquent. The number is 4.34% or prime mortgages. As argued in the Growth Perspectives

section, we believe that it is likely that the economy will deteriorate continuously or a three-year period. Thus, both rom

a time and a loss/writedown perspective, we estimate that we are currently about a third into the crisis until we begin

seeing real economic expansion again. But what should one look or in order to capture the recovery? Let us rst stipulate

what will happen to the most important indicators.

1) US Personal Consumption YoY will stay below zero or at least six quarters. A reasonable sign o recovery will be to see

it above zero or at least two consecutive quarters.

2) The Credit/GDP ratio will probably spike due to a temporary drop in nominal GDP. 2) This ratio will trend lower or the

next two decades, but once it stabilizes in the downtrend, a recovery might be on the way.

3) Total Assets: Loans and Leases in Commercial Banks will drop, because banks will try to deleverage and restore solvency.

Currently standing at $1.6 trillion, the measure will probably drop at least 20% and needs to stabilize – i.e. the commercial

bank system needs to lend again – beore we have a sustainable recovery.


– 26 –



FX IN 2009: ANOTHER WHIPLASHREVERSAL AHEAD FOR THE USD?

The great credit bubble unwind o 2008 made or remarkable moves or all asset classes. And currencies were at the

centre o the maelstrom as global markets began destabilizing by mid year and then melted down into September and

October. A ew metrics on the madness that hit currencies in 2008:

- Starting 2008 around the 2.0000 mark, GBPUSD plummeted as much as 25% beginning in mid-summer to six-year lows

well below 1.5000 by the late all. By early December, EURGBP had risen over 20% on the year.

- Ater hitting a 10-year high above 1.6800 in October 2007 as global equities notched record highs, EURCHF celebrated

it’s 1-year anniversary o that mark in October 2008 by plummeting to a record low (and then reversed more than hal o

those losses by mid December to complete the total whiplash eect).

- AUDJPY, the benchmark carry trade among the G-7 currencies due to the large interest rate dierential , saw its 20-dayaverage trading range move rom about 100 pips (about 1% o spot) over the summer, to over 500 pips during the panicky

days o late October. A 500% increase in volatility!

- In EM, South Arican Rand lost over 40% o its value against the US dollar ater enjoying several years o relative stability.

At the ar end o the risk spectrum, the Icelandic krona became completely non-convertible as Iceland’s banks seized up.

So what will 2009 bring or the major currencies? Our original idea or 2009 was that the rst part o 2009 might look

like the last several months o 2008: that is, another another vicious round o deleveraging combined with a urther

strengthening o the USD and the JPY and weakness in those currencies most closely associated with the previous global

growth cycle like CAD and AUD.

But just beore year end, the Bernanke Fed has issued a declaration o all-out war on defation that will entail a massive

expansion o the Fed’s balance sheet and the outright printing o money – a very aggressive stance even earlier than we or

certainly the market anticipated. The BoE and BoJ seem to be more or less ready to ollow the Fed’s lead. But the ECB has

stood up and seems to be talking up a more hawkish stance o slowing and even stopping rate cuts and even criticizing what

the Fed is doing by warning o its infationary. The divergence in policy trajectories and tension this creates is explosive

and is a virtual guarantee o enormous volatility in this supermajor in 2009. Intended devaluation vs. the capital fows and

sae haven seeking o deleveraging – which theme wins out in 2009?


– 27 –



USD: ONE MORE ROUND OF STRENGTH - THEN GOODBYE GREENBACK.

As we entered 2008, the US dollar was weakening due to the already advanced state o malaise evident in the US

economy stemming rom the suprime-housing debacle and spreading credit stresses. The Fed had already launched an

aggressive rate cutting regime while infation pressures were mounting all over the rest o the world. The market built

up enormous short USD positions in the rst hal o the year on these disconnect in the global economy, the so-called

“decoupling” theory, carry trades, and short USD/long commodity macro plays. European and other banks unded massive

liabilities in the US commercial paper market at attractively low rates. Then, when the credit crunch went global a vicious

wave o deleveraging o outstanding positions gave the greenback a turbo-boost that saw the dollar index rise over 20%

in short order. USD/EM crosses were the biggest gainers as short USD/long EM currencies and short US stocks/long EM

stocks had been one o the most popular macro plays, even among US investors, who had long ago given up on domestic

equities and were investing abroad like never beore.. As we head into 2009, the USD rally has pulled back very sharply

due to the Bernanke Fed’s declaration o war on defation. We see a binary potential or the USD in the new year. There

is still the chance that another round o deleveraging and asset liquidation sees the USD move stronger again vs. most

currencies. Longer term, the extremely aggressive move by Bernanke to move to a super-expansive stance is a clear eort

to devalue the USD to avoid debt defation. Eventually, Mr. Bernanke will succeed.

Trade: Sell EUR/USD above 1.6000 with a target o 1.2000 / Buy EURUSD at parity whichever comes frst. Buy USD/CAD,

targeting 1.4500

EURUSD in 2009:

A binary scenario: I it rallies much more, it’s a huge selling opportunity. I it alls to low, it’s a cyclical buy on the eventual

USD devaluation.


– 28 –



EUR: SAFE HARBOR OR AN ACCIDENT WAITING TO HAPPEN?

In the last weeks o 2008, the EUR has rallied steeply against most G-7 currencies as the ECB has taken the clear position

that it is reluctant to join the competitive devaluation game being played by the Fed and the BoE. While scal austerity

and worries about the infationary implications o devaluation may be admirable, this stance is brutally strengthening the

Euro - a trend that will not be sustainable in the New Year. This trend is guaranteeing a very hard landing or the EuroZone

economy and likely the worst defation in the world as long as the ECB and the EuroZone countries reuse to go all out

with the printing presses like the rest o the world. We suspect that circumstances and internal strie in the EU will eventually

orce the ECB kicking and screaming to move rates toward the zero bound as well.

The EUR is looking awully expensive as we head into 2009, and we suspect that dark clouds may be gathering over the

single currency’s viability by later in the year, with the possibility that one or more countries in the union, such as Italy or

Greece, threatens to leave the currency union due to the painully strong Euro’s devastating eects on their economies.

Note that 10-year government debt or the Italy, Greece and other EU members trades at a signicantly higher yield than

Germany debt already – over 130 basis points in the case o Italian 10-year notes as o mid-December. Any threat to the

EU’s integrity would have disastrous eects on the currency as world reserve managers could seek to diversiy their EUR

exposures. We’re also very concerned about European banks and their huge exposure to CEE economies and potential or

signicant levels o deault on loans made abroad during the bubble years.

Trade: Sell EURUSD i it reaches above 1.6000. Sell EURJPY or a test o 95. Sell EURAUD and EURNZD as the major equity

indices sink to new lows.


– 29 –




– 30 –

JPY: A ROCKY ROAD FOR 2009 AS JAPAN FIGHTS JPY STRENGTHENING PRESSURE

The JPY carry trade ended with a bang in 2008 with the massive unwind in global assets. Outfows rom Japan were

choked o, passive carry traders were taken to the cleaners, and the long oversold JPY rapidly sought a airer valuation.This process is not yet complete at we head into 2009, but the path o JPY strengthening may be a ar rockier one in the

months ahead. On the one hand, the urther the JPY strengthens, the more it is inficting real damage on Japan’s export

dependent economy, and as well, the Bank o Japan is likely to begin intervening against JPY strengthening pressures as

it has already sought explicit permission to do so rom other G-7 members. So while we are bullish the JPY or at least

the rst hal o the year while the global deleveraging plays itsel out, the trade will be a dicult one to enter and exit

in terms o risk/reward. Since we don’t look or a recovery any time in 2009, we suspect that the carry trade will remain

a dead concept or the oreseeable uture and will be a “buy on total panic i you dare” type o trade in 2009. Still, in a

global economy where so many nations are wallowing in endless debt, it is tough to bet against a nation whose population

has savings o well over 100% o US GDP.

2009 Trade: Sell EURJPY or 95. Sell CADJPY, targeting 65 or lower. Sell AUDJPY or test o 45.00

AUDJPY in 2009:A continuation o global deleveraging will put urther pressure on the classic carry trades, but i equities nally put in a

low, there will also be great tactical buying opportunities i the world gets too doomy and gloomy




– 31 –

GBP: MOST OF THE PAIN ALREADY PRICED IN?

GBP tumbled to spectacular new lows by mid-December o 2008 as the UK economy was by ar the most vulnerable o the

European economies to the credit crisis. First, the economy’s only major export is nancial services, the sector hardest hit bythe crisis. Second, British banks have enormous liabilities abroad at several multiples o British GDP. Third, the pound was

overvalued to begin with and once the BOE got aggressive in cutting rates, its traditional yield advantage was no longer

there to prop up its attractiveness rom a carry perspective. Finally, the UK had a housing bubble perhaps even worse than

the US housing bubble and this is in the rapid process o unwinding as we head into 2009. The British consumer is one

o the world’s most indebted (perhaps tied with Australia). The good news? The short GBP trade was one o the most

obvious and heavily played macro themes in 2008 and has become a crowded trade. The market is already pricing in an

awul lot o misery or the UK on top o what it has already experienced, so we suspect that GBP could stage a strong

comeback somewhere in 2009 against its European peers at minimum, even though the BOE seems happy to let the

pound continue to weaken or now.

2009 Trade: sell EURGBP or 0.8000 again and Buy GBPCHF dips or test o 1.9500

CHF: NO LONGER A SAFE HAVEN?

The Swiss Franc perormed a Jekyll and Hyde act in 2008 as the credit crisis swept through the markets. At rst, the ranc

strengthened sharply in line with the sharp contraction in risk appetite as it has nearly always done in markets past. The

assumption was that CHF had been used extensively as a unding currency involved in carry trades and anything carry

related should reverse. But then, ater posting record highs against even the EUR, the CHF quickly began weakening

against the EUR and elsewhere by later in 2008 as traders and macro investors contemplated its exposure to the nancial

sector. Although it became increasingly popular, especially or mortgages in Central and Eastern Europe, to borrow Swiss

Francs as a unding currency or asset plays abroad, Swiss banks and investors also invested abroad to the tune o several

multiples o the country’s GDP, so oreign liabilities and are a tremendous risk. Further cracks showed in the ranc as serious

tax haven issues arose with US and German authorities – possibly tarnishing Switzerland’s ability to attract capital downthe road. We’re neutral on CHF heading into 2009. Still, the ranc may outperorm the Euro in the New Year.

2009 Trade: Buy GBPCHF or test o 2.0000. Sell EURCHF or 1.4800 again.




– 32 –

AUD: TO REMAIN DOWN UNDER?

The Aussie was caught up in the dual bubble in commodities and emerging market currencies and remained strong

until those two markets peaked in mid-summer o 2008. The unwind since then has been spectacular and likely heavilyaggravated by the unwind in enormous carry trade positions built up over years. The outlook or AUD remains very poor

as long as global growth prospects remain weak, which we expect them to do or the balance o 2009 (i with considerable

volatility in price movements, we must note). The Australian economy has lagged the weakness developing elsewhere

by, and thereore has a lot o catching up to do in 2009. AUD will be especially sensitive to any worse than expected

slowdown in China, due to key exports to that country, especially iron ore and coal. This latter risk is signicant but o

unknown magnitude due to the opacity o China’s real economic perormance.

2009 Trade: Sell AUDUSD or 0.5000 test . Sell AUDJPY or 45.00 test. Buy AUD basket i S&P500 hits 500

CAD: A HAS-BEEN UNTIL 2010?

The Canadian dollar was a bit slow to weaken in sympathy with the other commodity currencies this year, but once oil

prices collapsed, its ate was sealed and USDCAD quickly moved rom just over parity to 1.3000 in the space o a month.

The Canadian economy has always been closely coupled to the US economy as a majority o its exports, commodity and

otherwise, head south o the border. Still, Canada has remained surprisingly resilient until the nal months o the year,

when it became painully clear that the credit crisis had gone global. The loonie will continue to suer in 2009 on a broad

basis due to alling hard commodity prices associated with weakness in global growth. Weakness in the US auto sector

is also a concern as auto parts are one o Canada’s major manuactured exports. It seems that the weakness in Canadian

number is only beginning to pick up steam as we head into 2009, so it has a lot o catching up to do with its neighbour

to the south. Still, we don’t look or a meltdown: Canada was one o the most scally responsible countries in the world

in recent years and is relatively well positioned heading into this mess compared with other major economies.

2009 Trades: Buy USDCAD or 1.4500. Sell CADJPY or 65.00 or lower.

NZD: FURTHER TO FALL...

The NZD was the weakling o the G10 currencies in 2008 or good reason. The country’s economy was ahead o many

others in weakening due to its own credit/housing bubble that was ended with sharp increases in the RBNZ cash target to

above 8.00% by the summer o 2008. Now the central bank is cutting rates uriously to ght economic weakness and the

vicious unwinding o the domestic asset bubble. Still, New Zealand has a long way to go toward balancing its economy,

as the enormous current account decit demands extensive external nancing that will be hard to come by in the New

Year. As well, imploding agricultural commodity prices are cutting o export revenues. Fortunately ro the country, it has

done a good job o balancing its budget until recently so the country may be worth a look in the darkest days ahead once

it has taken a large urther adjustment.

2009 Trade: Sell NZDUSD or 45.00 test. Buy NZD basket i S&P500 hits 500 or a 10% rally.




– 33 –

NOK AND SEK: WORTH A LOOK IN 2009?

The Scandies have weakened sharply in 2008 or good reason. In Norway’s case, the traditional correlation with oil prices

almost inevitably meant that NOK would weaken. Besides the correlation with oil prices, NOK had become a popularcarry trade currency due to the hawkish Norges Bank’s raising o rates to as high as 5.75% by mid-year. Alas, its exposure

to commodities, poor liquidity, housing bubble unwind, and now rapidly shrinking interest rate dierentials means that

EURNOK Is trading at multi-year highs. Sometime in 2009, however, we suspect that the NOK could be worth a look on

a valuation basis and as the EUR is at signicant risk o coming under re.

SEK has weakened drastically as its export markets are going up in fames and as its banking sector is in trouble due to

enormous and ill-advised investments in the worst o the bubble economies o Eastern Europe – the Baltic countries. As

global deleveraging and economic weakness plays out, this could continue to weigh on the krona, but we suspect that

its value vs. the Euro is already beginning to get stretched as we head into 2009, considering that it still is has a current

account surplus and managed to run budget surpluses until this year. Sweden certainly looks ar better positioned than

many o the EuroZone member countries or weathering this recession. As well, in December, the Swedish National Debt

Oce has eectively announced intervention as EURSEK rose above 11.00.

2009 Trade: Sell EURNOK as crude oil runs below $40 or 8.50 and se ll EURSEK or sub 9.50 again.

EURSEK in 2009:

The Scandies are underpriced and the strong EUR is starting to look like a bubble: The Swedish government has begun

intervention and this pair may all hard in the New Year.



ENERGY IN 2009: FALLING CRUDEPRICES A HUGE GEOPOLITICAL RISK

The global slowdown triggered by the rapidly defating credit bubble pushed crude oil prices over a cli by mid-summer

o 2008. In just a ew months, the shocking reversal in prices has torn the economic rug out rom under all o the major

oil exporters. Unortunately or most o these petro-states, their leaders did a remarkably poor job o managing their

economies during the boom years: they squandered oil wealth on lavish domestic subsidies and allowed the infation o

massive local asset bubbles due to inappropriately pegged currency regimes. Now, with global demand declines suddenly

outstripping every attempt by the petro-states to cut production and exports, these countries may ace a urther sharp

drop in oil prices in 2009.

The greatest risk rom the events unolding in the global energy market is that prices all so ar and so quickly that they

destabilize one or more o the shaky petro-regimes that have already suddenly ound themselves on lie support. And,

ironically, the harder oil prices all, the higher the risk o a uture supply shock. A supply shock could be brought about in

the short term by a collapsing oil regime – a la 1979 in Iran - or in the longer run simply due to the abrupt contraction innew investment that is already drying up uture supply potential when demand bottoms and tries to make a comeback.

Collapsing oil prices are the most likely source o urther political and economic destabilization and geopolitical challenges

in 2009. And o all the major oil exporting powers, Iran is likely the most important.

When oil prices reached $145/barrel over the summer o this year, a day o global oil production had a spot market value

o $12.3 billion dollars. Saudi exports alone were worth well over a billion dollars a day at that incredible price. That high

price would have put annualized, global production at some $4.5 trillion. Now, however, prices have allen as much as

$100/barrel, and global daily crude production is worth less than $4 billion/day. This precipitous drop in prices has put

petro-states around the world in the grips o intense economic agony. As we head into 2009, a global infationary boom

has viciously morphed into a defationary bust in the matter o a ew months. Russia, the world’s greatest oil power next

to Saudi Arabia, has seen the market feece its oligarch billionaires o the lion’s share o their assets and the ruble aces

a collapse. Dubai, the UAE’s attempt to create a Middle Eastern nancial hub, sports empty “see through” skyscrapers

that attest to the implosion o the city’s property bubble. Venezuela’s populist Chavez looks increasingly against the ropes

politically on the homeront. O all the major oil exporters, however, things look worst or Iran.

Iran aces perhaps the greatest pressures o all the major oil exporters as crude prices decline because the government’s

outlays rose in an entirely direct proportion with the rise in the price o crude oil, meaning that the downside is creating

the most pressure on this country’s current economic model. Rather than building up nancial reserves while times were

good, the Iranian regime chose a disastrous policy o continuing and expanding massive subsidies, aimed at propping up

support or the regime among the nation’s poor. The lack o discipline in recent years has kept gasoline at the absurdly low

price o 11 cents a liter (with the guaranteed low prices resulting in the awul triumvirate o lack o investment in rener-

ies, booming domestic consumption, and massive exodus o large portions o oil export revenues or the purchase o gas-

oline. Unbelievably, Iran is the world’s second largest importer o gasoline ater the USA. The gasoline import situation became

so grossly expensive in 2008 that Ahmadinejad was orced to enact highly unpopular gasoline-rationing measures in 2008)

Those subsidies o uel and ood amount to as much as 20% o GDP, and oil revenues rom exports make up approximately

80% o Iran’s oreign exchange revenues. It is clear that the Iranian economy is a one-trick pony. Various estimates assume

that Iran needs a price o oil between 80 and 90 dollars a barrel to und its current budget. With international nancing

unavailable due to its isolation and oil prices running as little as hal o that, Iran is now quickly burning through its oreigncash reserves in an eort to maintain the over-generous subsidies while it hopes crude oil prices recover.

Eventually in 2009, the government will be orced to cut subsidies meaningully, a measure that will inevitably erode

support or the increasingly unpopular regime. The nation is headed or elections next June as the country is suering

30% infation and going into an economic tailspin. What is to become o Iran in 2009 is perhaps the most important

geopolitical question in 2009. The combination o the elections, the destabilization and unpopularity o the regime as oil

prices collapse, and the as yet unresolved issue o Iran’s nuclear ambitions make or a heady cocktail indeed. Add to this

Iran’s renegade status in the West, it’s implications or the Sunni/Shi’a aultline running through the Middle East, its con-

rontational stance on Israel, and its importance as a source o imported oil or large Asian powers and the implications

are clearly global. Either Iran’s economic weakness orces a more conciliatory response with the West due to the clear

economic exigencies, or the regime strikes out as it nds itsel in its death throes in an eort to cast blame on oreign

scapegoats. Iran’s is a potential powder keg in 2009 that bears watching.


– 34 –



Supply and Demand and the Amazing Crude Oil Price Curve

The oddest eature o the oil market as we head into 2009 is that it prices are in unprecedented “ultra-contango” in

which spot crude prices are extremely low compared to orward prices or crude oil or delivery in the uture. As the

chart below shows, the contango or 1-year orward crude has reached as high as 15 dollars in late 2008 as demand has

collapsed. The contango certa inly tells us that spot demand is extremely low at the moment due to the global economic

collapse. The sharply higher prices urther out on the curve supposedly mean that the current low prices are not expect-

ed to last. But is that the correct assumpt ion? Oil demand is collapsing around the world, just as supply was beginning to

increase a bit despite warnings o an impending permanent production peak. Analysts have long assumed that demand

can only rise or the world’s most important commodity, but it orgets relevant historical examples i sharply alling

demand rom price and/or demand shocks. For example, rom 1978 to 1983, US crude oil demand ell 20% and

did not reach the 1978 level again until 1998. Ater the Asian crisis in 1997, South Korean demand quickly shrank

almost 15% and has yet to rise above the 1997 peak.

Here’s another twist on the situation: at current levels o contango, anyone with the ability to store signicant

amounts o oil has a ree money trade at the moment: they can buy crude now, store i or a year and come away

with a tidy prot by locking in one-year orward prices right now. In the current market environment, there arevery ew ree money trades out there, so this one is likely to go away quickly as 2009 progresses- either via spot

crude rising versus orward crude or vice versa or both. We suspect that most o the pressure will be on orward

crude prices alling even urther, although contango is unlikely to disappear entirely. And barring any supply shocks

rom destabilizing petro-states, the crude market is likely to remain well supplied in 2009. Still, or the longer term,

crude oil supply is showing signs o peaking and the current global nancial malaise is already pinching petro-

leum companies’ E&P budgets. Oil production eorts have an extremely long lead time, so whenever the global

economy does right itsel somewhere down the road, the energy market will have a tough time responding and

the next price spike will be the inevitable result. A demand-led recovery in crude is not in the cards or 2009.


– 35 –

20 160

15140

10

120

5

100

0

80

60

40

-520

-10 0

1 / 3 0 / 1 9 9 8

1 / 3 0 / 1 9 9 9

1 / 3 0 / 2 0 0 0

1 / 3 0 / 2 0 0 1

1 / 3 0 / 2 0 0 2

1 / 3 0 / 2 0 0 3

1 / 3 0 / 2 0 0 4

1 / 3 0 / 2 0 0 5

1 / 3 0 / 2 0 0 6

1 / 3 0 / 2 0 0 7

1 / 3 0 / 2 0 0 8

CRUDE OIL IN CONTANGO

1 yr. orward Crude premium Spot Crude Oil Prices




TOP TEN REASONS TO STOPWORRYING ABOUT CLIMATE CHANGE

Climate change catastrophist propaganda has created one o the global economy’s gravest dangers as we head into

2009: global warming groupthink. Despite the economic meltdown we’re suering, bureaucrats are scrambling to enact

bizarre, carbon cap and trade schemes in coming years that can only serve as a heavy additional tax on economic activity.

Stopping the global warmist conspiracy will be a tough task in 2009, as it has also indoctrinated US president-elect

Obama, who may be about to embark on a climate change agenda o disastrous proportions by marrying a warmist

agenda to a super-Keynesian “green jobs” stimulus package. But as a public service and call to rationality, we are happy

to oer here the top ten reasons to stop worrying about climate change as we would hate to see climatic bugaboos

wrecking our global economy even worse than it has been wrecked to date.

10. The climate is always changing.

Climatic conditions have been a vital component o our planet’s and humankind’s history. The Roman Empire’s northwardexpansion, or example, coincided with a dramatic warming o Northern Europe, which allowed Roman agricultural

methods readily to expand northward. A subsequent cooling coincided with the Roman’s demise. The sharp warming

preceding and during the Middle Ages was an enabler o agricultural productivity and a population and cultural explosion

in continental Europe. It also aided the Vikings’ bold seaaring eats and ability to settle in a Greenland ar warmer than

today’s. By the late 14th and early 15th century however, as the “Little Ice Age” settled over the Northern hemisphere,

dramatically cooler conditions had brought about both the Norse Greenlanders’ rosty demise and disease and death to

mainland Europe as well. Prolonged droughts killed o the Mayans over a millennium ago and ailed monsoons and other

el Nino-like drought conditions in the late 19th century triggered huge amines in India and elsewhere. Climate change

has played a major part, or better or worse, in our history and will continue to do so until the sun dies billions o years

hence.

9. Climate models = garbage in, garbage out.

The world’s climate is one o the most devilishly complex “systems” we humans have ever tried to understand with computer

models. While our sciences have becomes enormously sophisticated and our computer power continues to grow expo-

nentially, we still can’t predict the weather with any accuracy more than about a week ahead at best . To take another

example, annual orecasts or hurricane ormation probability in the Atlantic, are laughably inaccurate. It is probably

hubris to think that we can ever reduce the earth’s climate to a computer model as the endless input variables into the

system mean that any inaccuracy that is used as input or a model with so many variables becomes multiplied a trillion

times over time as each time that inaccurate input variable interacts with hundreds o other inaccurate input variables

the variance to “reality” grows apace. The end result? A worthless prediction no better than a random guess. But that

certainly doesn’t mean we shouldn’t try. I some day orecasters are able to get it right once in a while then we should

start listening – until then, let’s give a ew million dollars to the model eggheads to see i they can come up with some-

thing interesting and consistently predictive rather than taxing our multi-trillion dollar regulations.

– 36 –



8. Where’s the warming?

It’s an inconvenient truth that the world has shown no convincing signs o warming since 1998: tied with 1934 as the

warmest year on record. The press continues to cover climate change topic in the present tense – as i we’ve already set

the thermostat higher and we’re slowly roasting ourselves toward the broiling point. The jarring reality is that the last twoyears have seen some o the most remarkably cool seasons in multiple parts o the globe or generations. Is it not ironic

that as Mr. Obama is headed or the White House next month, many parts o the US are descending into the coldest winter

in modern memory? Temperatures that would be colder than normal in the southeastern US or January, or example,

already slammed this region in mid-November. This past October, Southeast England saw a snowstorm this year that was

the most remarkably early sign o winter since 1880. And how’s the Arctic ice doing these days? Ater handwringing o

near religious intensity by global warming alarmists about the “record low” (or the ridiculously short data record o 30

years) Arctic ice cover in 2007, the ice has now expanded so rapidly due to extreme cold this year that it is already back

to the average levels or the last 30 years. Shall we continue? Lets! The South American winter o 2007 was the coldest in

three generations, with almost unheard o snow in Santiago, Chile and rosts in Uruguay. China’s brutal winter o 2007-8

was the coldest in 100 years and caused unprecedented travel disruptions. While warmists mourn Arctic ice disappearance,

they neglect to mention that Antarctic ice cover showed the largest growth last year since measurements began . And

Antarctic Ice contains 90% o the world’s ice. As or the “warming trend” that has been reasonably well established since

the 1970’s (at least until 1998): The warmists have conveniently orgotten that the 1950s’ to 1970’s was an unusuallycold period in the last 100 years and many scientists in the 1970’s were actually retting about the risk o global cooling.

We’re not out to claim that we are in the process o global cooling – but let’s at least look out the window and recognize

that something does not add up here.

7. Other environmental problems are ar more pressing.

It’s unortunate that, o all the environmental problems our society aces, climate change, a uzzy, uncertain, long term

concept is pushing aside ar more pressing and real concerns or the environment and our civilization. Poverty (which

oten caused by and aggravates environmental degradation), soil erosion/desertication and management o resh water

resources are real and present dangers that deserve ar more attention than climate change. Our use o water resources is

o particular concern as too much o the world’s agriculture depends on ossil and other overutilized water sources. Let’s

prioritize our resources appropriately. We suspect that the popular appeal o the global warming conspiracy is a combination

o international bureaucrats love o big, globe-spanning government and the strange misanthropic environmentalist/anti-

capitalist impulse. Let’s look at measures that would benet humanity rather than bureaucrats.

6. Other climate models: Global cooling just as likely.

According to multiple climate models that ocus on other important climatic inputs besides greenhouse gases, the risk

o global cooling – and even another ice age – appears to be as high a probability as the notion that we are in danger o

cooking the planet. No, we are not predicting global cooling, but let’s admit that other inputs into climate could be as

important or even more important than greenhouse gases. Variations in the sun’s magnetic eld, or example, are suspected

to be critical or the amount o cloud cover in the world – a key climate variable (water vapour is a ar more important

greenhouse gas than carbon dioxide or methane) . Understanding the sunspot cycle is also vital, as it may be one o the

most important climate actors o all. The coldest parts o the Little Ice Age (approx. AD 1300-1850) coincided with little

and even no sunspot activity. The very cool weather this year may also be due to a very low sunspot cycle. Projections o

the next cycle suspect that it could be a very mild one, meaning potentially cooler conditions.


– 37 –




5. The data is awed.

Headlines rom October o this year trumpeted that October 2008 was the second warmest October since 1880. As o

early December, you can still google this news story and nd this report presented as act. But guess what? It’s wrong.

Many had a hard time believing this report in the rst place as cooler than normal conditions were being measured in thelatter part o October. Then it was discovered by the blogging outt at climateaudit.org that the data used to calculate the

average temperature was simply wrong. Data or all o Russia was absent and instead was simply copied rom September.

Voila – record warmth. Others have discussed the risk that heat island eects in many cities around the world may be

skewing measurements unrealistically in the avour o warming in recent decades – especially across the huge expanses o

Russia, where temperatures have been the most suspiciously elevated (and which represents a very large landmass when

calculating global “averages”). Others point out unexplainable upward adjustments by the public agencies responsible

or producing climate data – especially the US’s NASA and NOAA and general attempts to treat climate databases and

the results drawn rom them as secret inormation rather than part o the public domain. Let’s at least ensure we have

accurate data collection beore we start rearranging our economic lives as i we are rushing toward a climate calamity.

4. Human activity helped created our great climate in the frst place.

One core belie held by many environmentalists is that all human activity is bad, that we are somehow to be punishedor our voracious and short-sighted consumption o the world’s resources. While we are certainly responsible or plenty

o regrettable destruction o many ecosystems and other environmental problems, our presence on this planet likely also

helped to create the climate we live in today. Climate change has been swit and brutal in the past and there is mounting

evidence that our presence on the planet has actually helped to smoothe out the climate’s climate cycles, perhaps due

to huge emissions o greenhouse gases. Particulary, some research (see March 2005 issue o Scientic American, or

example) indicates that humans’ mass burning o orests as agriculture spread to Europe and Asia thousands o years ago

helped to stabilize the global climate as the normal ice age cycle was suddenly aborted rather than repeating itsel. Many

credible climate models suggest that another ice age may be due in coming centuries. The possible good news? All our

greenhouse gas emissions may help save us rom an ice age catastrophe once again ...

3. Peak oil is here. Peak hydrocarbons soon to ollow.

We live on a nite planet with nite resources. Most o our entire civilization has been made possible by the greatest

resource o all that natural history has bestowed upon us: stored solar energy in the orm o ossil uels (coal, crude oil

and natural gas). Yes, we should be worried about burning hydrocarbons, not because o climate change, but because

this resource is nite and won’t last orever and we should make the best possible use o it. Conventional light crude oil

resources peaked a ew years ago and overall liquid hydrocarbon production may have also peaked, and i not, will do so

in the coming ew years. Natural gas will soon ollow, and the nemesis o the global warmists – King Coal – will ollow

within another decade or two. Most o the climate change worry wart’s models assume that our ossil uel usage will

continue to expand apace - but our limited endowment o ossil uels guarantees that we will orced to slow emissions

anyway in coming decades.

– 38 –



2. Climate change policy is lousy economics.

The articial imposition o anciul carbon “cap and trade” schemes cooked up by world bureaucrats are the eective

equivalent o a severe tax on industry and economic activ ity generally. The various policies are probably not implementable

in the rst place as cheating would be rampant and easy by nations without strong traditions o enorcing complicatedregulations. Costs would likely be highest or those countries – especially Europe – where enorcement would be carried

out in ull. Implementing these draconian regulations would be costly and onerous in the best o times. Right now, we are

in the worst o times and can ill aord these programs. I implementation is carried out, watch how the “renegade” states

with rich coal reserves enjoy tremendous growth at the expense o the chump nations who swallowed the cap and trade

pablum. This is a critical issue as Obama is clearly marching to the White House with visions o marrying climate change

alternative energy programs with some kind o super-Keynesian new stimulus package to create millions o “green jobs”

in the US. Remember Jimmy Carter’s wasteul white elephant investments in new alternative energy technologies? Is the

Obama administration doomed to repeat these mistakes?

1. “In the long run, we are all dead.”

The ull quote, rom John Maynard Keynes, is as ollows: “The long run is a misleading guide to current aairs . In the long

run we are all dead”. No, this isn’t a atalist proession o doom and gloom - it really sums up the nine points above andshould serve as a call to ocus on things that are happening in the here and now - to shape things we know that we know

about rather then things that we really don’t know i we know about. The worst thing we could do or the environment

would be to see a total economic collapse: as poverty and environmental degradation go hand in hand. Let’s let the global

climate take care o itsel or now.


– 39 –

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Saxo Outlook 2009

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