What a difference a year has made.
At the start of 2009, all was dark and gloomy amidst the greatest financial crisis the world has seen.
Now, in 2010, there seemed to be a lot of optimism, at least among the people I spoke to who are starting to invest into stocks again.
Ironically, those who have made the most money would be those who have invested in the depth of the crisis and held on to their holdings.
The stock market is driven largely by sentiment and if sentiments change, the direction of the market can also change.
What are some factors that can threaten to trigger a change in sentiment?
The US dollar, forsaken just a few weeks ago, has staged a remarkable rebound since the starting of December 2009. Nearly everyone was bearish on the USD back then and it has appreciated nearly 5% against both the euro and the Japanese yen.
The appreciating US dollar has raised concerns that it could derail carry trades. In the past year, the cheap USD has been used as a funding source into more risky assets. If the dollar continues to strengthen and some of these carry trades are unwound, it could trigger a fall in riskier assets like stocks, commodities and other currencies.
The bailout from Adu Dhabi has prevented a crisis for now. However, this does not guarantee a bailout in the event of a future default. Already, there has been increased concerns over other debt-laded governments like Greece.
Australia had been the first developed country to increase their interest rates. Most of the other governments are threading a thin line between maintaining their current policy or tightening them. The fear is that tightening too early might lead to a adverse effect in the economy again. On the other hand, if monetary policy is kept loose for too long, it will ultimately lead to inflation with risk of asset bubbles forming.
Looking beyond the recovery numbers, you can still see banks failing in the United States practically every week. Bad mortgages are still bad and the question is whether the medicine has been enough or correct. To quote Marc Faber:
If we agree that excessive credit and excessive leverage led to the crisis, then what the Federal Reserve is doing is giving a wrong medicine to the patient – they are giving the drug addicts more drugs instead of sending them to rehabilitation, which is not good for the economy.
If the medicine is wrong, then problems will resurface, not now – but maybe one or two years down the road.
In hindsight, the past two years had been a great learning curve. Now, I am more convinced than ever that most people are doomed to making losses or dismal returns when they invest. More on that in a future post.