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2010 Capital Markets Outlook and U.S. Economy Forecast

As part of our annual portfolio reconstitution process at Hennion & Walsh, we strive to build forward looking, asset allocation-oriented portfolios based on our internal views of where we believe both the markets and economy are heading for the next year. For your benefit, I have provided our five potential scenarios for 2010, based upon information available to our research team at this point in time, with an internal probability assigned to each, below:

Scenario 1:
Transition Year
Probability Assigned:
40%
Scenario Description:
This scenario is predicated on the understanding that the year following the initial recovery year from a bear market is often characterized by a pause, more volatility and uncertainty. These years may often coincide with a mid-term or election year – which is the case this year. Unwinding quantitative easing measures and possible interest rate hikes create intermittent starts and stops throughout the year. Overall market results are probably close to conventional market returns, similar to the trendless volatility we have witnessed with respect to the S&P 500 index over the most recent 10 year trailing time frame.

Scenario 2:
Deflationary Stagnation (i.e. “L” shape recovery)
Probability Assigned:
20%
Scenario Description:
This scenario would occur if the economy proves too weak to resume sustainable growth in the absence of, or prospect of, less government support but not so weak as to fall into a “double-dip” recession. Under this scenario, unemployment remains high, real estate prices do not fully recover on a national basis, and consumer demand remains soft. The velocity of money would also remain muted and commodity prices slowly decline.  All of these factors threaten a “Japanese style” protracted, anemic economy.  

Scenario 3:
Bullish Recovery Surprise (i.e. “V” shape recovery)
Probability Assigned:
15%
Scenario Description:
This scenario follows our belief that economists generally are not successful in calling market turns in advance. Markets traditionally recover strongly from strong declines. As a result, there is a “boomerang effect” not easily detected until after it happens. Following this effect, inventory draw-downs lead to an increase in orders which further leads to an increase in hiring and eventually, an all-important increase in consumer spending.

Scenario 4:
Return of Inflation
Probability Assigned:
15%
Scenario Description:
Under this scenario, the economy recovers and more dollars are chasing fewer goods causing prices to rise and inventory shortages to develop. Inflationary pressures intensify as the Federal Reserve either acts too late, does too little or adds even more money to the system through yet another stimulus package. In considering this scenario, one should remember that the technical definition of inflation is when money enters the system at a quicker pace than it is leaving the system.

Scenario 5:
Double-Dip Recession (i.e. “W” shape recovery)
Probability Assigned:
10%
Scenario Description:
The scenario is the extreme version of scenario #2: Deflationary Stagnation; where the economy proves much too weak in the absence of, or prospect of, less government support and/or a Sovereign Debt, Credit, Geopolitical  or Real Estate related crisis occurs and pushes the economy into a dreaded double-dip recession.

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