Stock Market Developments

The stock markets of the world were at a time of indecision when we last wrote a week
ago. That indecision, spurred on principally by the decision of the government of the
USA to re-separate the functions of commercial and investment banking has become, at
least for the moment, a world bear market.

Figure 1.

Stock Markets in 2010

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DJI FTSE CAC 40 HSI Ibovespa S&P

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Figure 1, above shows the performance of six stock markets, based upon a comparative
analysis of their respective equity indices from the beginning of 2010. The indices chosen
are the Dow Jones Industrial Average (“DJI”), and the Standard and Poors 500 (“S&P
500”) of the USA, the Financial Times and London Stock Exchange 100 Index (“FTSE
100”) of the United Kingdom, The Cotation Assistee en Continu 40 (“CAC 40”) of
France, China`s Hang Seng Index (“HSI”), and Brazil`s Indice da Bolsa de Valores de
Sao Paulo (“Ibovespa”). 100% represents the index for each market at close of business
on the last day of trading of 2009.

We have become accustomed to seeing the IBovespa index being among the two best
performers between October 2008, and December, 2009. Indeed, we have been surprised
at the Ibovespa`s resilience given the Brazilian Government`s successful attempts to
discourage foreign investors from investing in the equity and fixed income markets
thanks to a flat tax at the moment of investment of 2%. However, in looking at the stock
market performance in through January 26th, we see a new picture emerging.

The two worst performing indices are those of the emerging markets represented, Brazil
and China. The HSI of China had been the front runner since the crisis for a long time,
but due to an increase in Yuan interest rates in November 2009, that market became
essentially static. The Brazilian market, as measured by the Ibovespa continued its climb
throughout December, reaching over 70.000 points on eight consecutive business days.
The new story, however is one of the HSI falling 8.1% in 2010, while the Bovespa has
fallen 4.5%. Meanwhile, the performances of the stock markets in the more developed
countries have fallen by: CAC 40, 3.3%, FTSE, 2.5%; the Dow Jones, 2.2%, and the S&P
2.1%.
What is going on?

First, there is a general lack of consensus, not so much about whether the world`s
economic situation will continue to improve, but how quickly. Secondly there are serious
concerns about the amount of liquidity in the world. There was an enormous amount of
artificial liquidity created by the various Central Banks to aid with the crisis, and that will
slowly be withdrawn through 2010. There is also the investor liquidity that was in the
market throughout 2009, but which has been absorbed through the acquisition of ever
more expensive assets. Thirdly, investors have seen markets rise rapidly over the last
year, and have come to the conclusion that the markets upward mobility is limited, and
thus they are withdrawing to other assets and other markets.

Also, investors in Brazilian stocks are becoming clearer about the effects of the crisis on
the Brazilian economy. While the story continues to be good there is more concern about
Brazilian Governmental indebtedness, and a bet that in an election year that indebtedness
will not be closely controlled. Also, of concern is the indebtedness of Brazilian
consumers which is growing a lot faster than income, and finally, the parlous state of the
trade balance which will probably only get worse, save a significant realignment of the
Real/ US Dollar exchange rates.