Many commentators are upbeat about prospects for the coming year. Among other reasons, they believe that severe recessions are invariably followed by sharp rebounds, even though history suggests financial crisis-inspired downturns tend to be protracted affairs. They are confident that various government-sponsored bailouts and stimulus programs have kick-started a sustainable recovery, even though many of the problems that caused the crisis have not gone away. They are encouraged by the sharp rally in financial asset prices. even though it has been powered by unsustainably cheap money and excessive speculation.
In truth, conditions are ripe for a very difficult year — for the economy and the markets. For one thing, governments, financial institutions, and property owners will be looking to raise or roll over trillions of dollars of debt, which will exert signficant upward pressure on interest rates. The growing ranks of the long-term unemployed, who have survived thus far on social safety net payments and vague talk of a recovery, will be forced to slash spending as companies live up to their own predictions that they won’t be hiring. Banks will further restrict credit and will seek to raise a lot more capital as ongoing weakness in real estate markets and the legacy of past lending mistakes causes losses to swell.
Under the circumstances, I expect to see share prices, which are pricing in a vigorous economic recovery and which are overvalued on many measures, give back most, if not all, of what they gained during 2009. Gold, oil, and other commodities will also be hit hard by weakening global demand and continued deleveraging. Government budget deficits, which are already dangerously high, will continue to expand, leading to growing nervousness about potential sovereign defaults. While 2010 won’t be as frighteningly bone-jarring, perhaps, as 2008 was, it will be no less painful for individuals and businesses around the world.