Minyanville's 2010 Mid-Year Review

The midpoint of 2010 has arrived and it’s time to take stock of what we’ve seen and where we’re going.

The first six months of the new decade have been anything but boring as we’ve witnessed events that may forever change the face of free-market capitalism. We traversed the depths of despair and the height of hope and the world is on edge as we ready for the back nine.

The following topics were offered as our Ten Themes in early January. Let’s recap them and update where we stand.

Theme 1: The Man Behind the Curtain
 

"The stock market is the world’s largest thermometer and the single biggest proxy of our collective financial health. In a finance-based economy laden with debt and mired in derivatives, the only “solution” to the financial crisis was to push risk out on the time continuum with hopes that a legitimate recovery will take root.

Following massive bailouts in the financial, housing, and automotive industries -- not to mention the curious absence of traditional sources of demand -- this redistribution of risk may emerge as a modern day Ponzi scheme."

Update: The musical chairs continue and the global stakes have never been higher; all the while, risk hasn’t been destroyed, it simply transferred from one perception to another. (See: The War on Capitalism)

During the first phase of the financial crisis, sovereign lifeguards saved corporate America. The natural question is therefore begged, who is left to save the lifeguards? While the first six months have been a battle, I believe we’re in the eye of the storm, a relative calm between the first phase of the financial crisis and the cumulative comeuppance that'll flush -- and perhaps reset -- the system. (See: The Eye of the Financial Storm)

Theme 2: Adapt, Don’t Conform
 

While credit markets suggest further equity strength is not only possible -- it’s probable -- the disconnect between stock prices and the underlying economy, or the chasm between perception and reality, continues to widen.

Conventional wisdom dictates that equities will enjoy further upside before facing headwinds later this year, akin almost to the mirror image of 2009. Respect -- but don’t defer to -- these choppy waves of optimism. When caught in a riptide, the surest path to survival is to swim parallel to the shore until the dangerous current passes.

Update: Last year, the S&P rallied more than 50 S&P points out of the gate, reversed lower to lose more than 270 points and bottomed in March before embarking on one of the sharpest bear market rallies in history.

This year, the S&P lost 70 points into the beginning of February, reversed 175 points higher and topped in April, establishing the first in a series of lower highs. S&P 1040 remains the level of lore. If that zone breaks, a pure technical lens suggests a measured move to S&P 860, or 18% below current levels. (See: The Market is Speaking. Are you Listening?)

Theme 3: The Tricky Tri-Fecta
 

In 2007, we previewed the deterioration of the middle class and the friction between the “have’s” and “have not’s.” In 2008, we forecast percolating societal acrimony. Last year, we spoke of the migration towards social unrest and geopolitical conflict.

As this dynamic evolves, real risk remains across the spectrum of social strife. While this assumes many shapes and forms -- populist uprising, the rejection of wealth and an emerging class war -- we should remember that global conflicts have been historically triggered by financial hardship.

Update: While some of those dynamics proved true -- societal acrimony, including a bulls-eye on the back of Goldman Sachs (GS), BP (BP), policymakers, and politicians, plus social unrest stateside and abroad -- others thankfully haven’t, at least not yet.

From the Flotilla friction to Iran tensions to saber rattling on the Korean Peninsula to recent reports that factions within Turkey have declared Jihad on Israel, with European social strife on the rise, and a global play for crude mixed in for good measure, sovereign posturing is ever-present and on the rise. Can you feel it?

Theme 4: The State of the States
 

States across the union -- particularly those that benefited from the housing bubble and the taxable income associated with it -- are now experiencing a massive reversal of those golden years. The decline is so swift that it will take several years for the real estate reset to flush its way through municipal budgets.

Additionally, The US public pension system -- one of our 2009 themes -- faces a higher-than-expected shortfall of $2 trillion that will increase pressure on strained finances and further crimp economic growth, according to the chairman of New Jersey’s pension fund, as quoted in the Financial Times.

Update: Illinois has pulled ahead of California in the “State Most Likely to Default” race, although they’re neck and neck (27.8% vs. 27.3%). To put things in perspective, both still trail Greece (57%) in the Big Picture Blues but they maintain a healthy lead on the dark horse Spain (21%).