The MSCI World index rose 3.7% in December, taking gains for 2009 to 27%, on ongoing signs that a recovery in economic activity was underway. In general, 2009 was a roller-coaster year for the global markets. In 1Q09, volatility and risk aversion caused de-risking on a massive scale as investors unwound all risky trades. But throughout 2Q09 and 3Q09, government and central bank support was a key driver of a return to positive readings in macro-economic indicators.

The outlook for 2010 remains blurred, especially in developed markets, where structural problems persist. Labour market conditions in the developed world are likely to remain weak and, as a result, consumption is set to be constrained. On the contrary, the recovery is occurring at a much stronger pace in emerging markets due to strong consumption and investment growth.

The growing possibility of a withdrawal of government support measures will be a key concern in 2010. And while equity valuations are not excessive, they are above the bargain levels seen in 1Q09, thus giving investors less of a cushion against negative surprises. However, there are interesting opportunities at the regional and sector level. Within developed market equities, we have a tilt towards defensive sectors. At a regional level within emerging markets, we see potential in Latin America.

We have a positive view on investment grade and high-yield debt as the current yield spread levels are still attractive relative to history and versus the very low levels of yields of government bonds. Within currencies, we maintain a moderately negative view on the GBP relative to the EUR.

• With the MSCI USA 12-month forward price-to-earnings ratio at 14.5x, valuations are not at an overly attractive level compared with history. However, the ongoing fiscal and monetary stimulus continue to be supportive. Therefore, given the overly optimistic expectations for both economic and corporate growth, we maintain a moderately cautious view on equities for the US and elsewhere relative to cash.

• Following the strong rally in 2009, valuations reflect a somewhat overly optimistic level of economic and earnings growth for 2010 making European equities less attractive with some risk for a correction. Therefore, we recommend a moderately cautious stance on European equities and maintain our moderate underweight against cash.

• Japan's economic outlook remains encouraging overall, but with deteriorating public finances and a deflationary environment, the risks from weak consumer demand and high unemployment rate are still high. We recommend a moderately cautious view on Japanese equities against cash and expect Japanese equities to perform in line with other developed equity markets.

• The macroeconomic outlook for emerging-market economies continues to be strong overall. But the risk of authorities (especially in developed markets) reducing economic support is increasing, weighing on the sustainability of the pace of recovery. Therefore, we maintain our moderately cautious view on emerging-market equities in general relative to cash, and we expect them to perform in line with their developed peers.

• The macro economic outlook for Asia-ex Japan is generally positive. Valuations have returned to levels consistent with the first half of 2007 and we believe market prices are largely reflecting the positive news flow. On the whole, we maintain a moderately underweight allocation to Asia ex-Japan equities versus cash, as we believe the risk for negative surprises has risen. Relative to other equity regions, we expect Asia ex-Japan to perform in line.

• The HK and mainland economies continue to benefit from a global recovery. However, how and when the monetary policies will be tightened will drive performance beyond the next few months. The key domestic risk is inflation as higher inflation could speed up monetary tightening. Policy settings continue to target increasing consumption. As such, some under-penetrated consumer sectors such as healthcare and dairies may look attractive.

• Subdued demand and ongoing variability in investors' risk appetite are likely to keep the oil price fluctuating in a range. Therefore, we maintain our target range for oil within US$60-$80. A key risk to our forecast is further USD weakness, which could push prices higher.

• We do not expect any increase in the Fed Funds rate during the first half of 2010, and possibly longer, which would be positive for government bonds. However, given the still-low yields offered by government bonds, among fixed income markets, we prefer to own corporate debt.

• Supply concerns could place pressure on Eurozone bond prices, as governments continue to issue record amounts of debt to support their economies. Overall, within fixed income, given the exceptionally low yields offered by government bonds, our preference remains for corporate debt on valuation grounds.

• Asian government bonds likely continue to outperform the US treasuries due to relatively low level of macro risk in Asia. However, the magnitude of outperformance is likely to be muted in contrast to the massive returns of 2009.

• Demand for investment grade bonds is expected to remain robust, as investors search for yield in what will remain a low interest environment in 2010. Therefore, we retain our positive view, although highlight that liquidity risk remains a potential issue.

• Liquidity, risk appetite and demand for yield remain supportive. Furthermore, fundamentals are still improving with companies focusing on balance-sheet repair. In addition, downgrade and default rates are set to fall in 2010, which could lead to further spread compression. Yet even at current levels spreads are still attractive, hence we reiterate our positive view, although stress that liquidity risks remain.

• From a valuation perspective, sovereign emerging market debt continues to look less attractive than developed market corporate bonds. Overall, we believe there is better value in high yield corporate debt than USD denominated emerging market debt.

• The USD's rally last month against major currencies was mainly attributed to the ongoing improvement in the US economy. But we do not believe there is sufficient fundamental justification at present to warrant a positive USD outlook given structural issues, high unemployment and weak consumption.

Canadian Dollar (CAD) – Consolidation Is Likely Over Short Term

• The appreciation of the CAD during 4Q09 appears to have outpaced the performance of riskier assets and some consolidation is likely. In addition, commodities, especially energy and precious metals are a major driver of currency demand.

Euro (EUR) – Maintain Moderate Preference For The EUR Vs The GBP

• Although December saw a fairly sharp reversal of the USD's fortunes, there is insufficient reason to infer that EUR/USD has established a declining trend. We continue to have some conviction on longer term strengthening of the EUR against the GBP because of the deterioration in the UK's public sector finances.

Sterling (GBP) – Maintain preference For The EUR Due To The UK's Worsening Public Sector Finances

• The UK's mix of fragile economic recovery and stickier inflation has the potential to create monetary policy conflict. The fundamental position of the GBP is little changed and we continue to believe that an underweight position against the EUR is justified given the UK’s weak financial position versus the Eurozone.

Japanese Yen (JPY) – Retain Neutral Position As Fundamentals Remain Unclear

• The government's revised stance on the JPY is more easily understood given the negative impact a stronger JPY can have on Japan's critical export market. The increased probability that the authorities will intervene to smooth currency volatility makes the JPY more attractive as a funding currency, which could put downward pressure on it. On the other hand, Japan's current account surplus results in a favourable comparison of the JPY against other low-interest-rate currencies. The net impact of these factors is uncertain.

AUD – The RBA Remains Its Tightening Bias

• Australian employment data was strong which helped consumer confidence remain high. As such, the RBA has a tightening bias, which preserves favourable interest differential. However, the AUD may come under pressure should the US Fed start the tightening cycle.