Not a great start for the new year, but it's just a correction

After the surge in the first week, the markets have been going down for three consecutive weeks. The best performing sectors (material, energy, technology) have turned into the worst performing ones. Is this a start of a new (down) trend? Or merely a necessary correction?

We think it's just a correction. The three sectors that have been performing well in 2009 are all tightly linked to global demands, especially in emerging markets such as China. China's extraordinary stimulus policies have largely avoided a slump that was widely believed to follow the financial crisis. But the result came with a big price: China is risking an over-heated real estate market reaching the bubble territory. The government, being an effective and anticipating manager of the economy, is trying to slow it down a bit before inflation breaks out. This has created concerns that this engine of global recovery may be running out of steam.

China is not going to slow down dramatically. It cannot afford to. It needs sufficient growth to provide employment. A small slowdown is good for the transition to a more balanced growth path, one that depends more on domestic consumption than export.

In the US, there are signs that the economy has started its slow recovery. The housing market has most likely reached some sort of bottom in parts of the country. Consumption has started to contribute to the GDP growth (4Q). US dollar may be on a new trend of strengthening, at least relative to Euro and other developed currencies. Commodities and energy may thus lose a strong support. Yet, we doubt this is going to last very long. The US recovery is still very weak. Mind-boggling national deficits will need more supports from the Fed. Consumers are still working through their debts. US will need all the helps it can get, including a weak dollar to help stimulate exports.

Emerging markets, which are fiscally much healthier than the US, should continue to grow more rapidly. We expect energy, material, and tech sectors to continue their relatively strong performance into 2010.