What's in store for 2010?

At the start of 2009, things looked grim. From this end of the year, they don't look so bad.

The FTSE 100 is up along with the rest of the world's stock markets. The British banking sector still exists, even if a couple of the big ones are largely owned by the taxpayer. And even house prices have rallied.

We're still cautious. There are plenty of tripwires for the world economy next year. But there are opportunities too.

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Let's take a quick glance at what we should be looking out for in 2010

There are plenty of hazards ahead

As my colleague Dominic Frisby noted yesterday, we've been too cautious this year in terms of the size and speed of the bear market rally. We've been tipping defensive stocks since early this year, but we've largely steered clear of the more cyclical companies that have led the market rally.

But we're not about to turn around and suggest piling into banks and commercial property. There are still plenty of major hazards awaiting the global economy in 2010. At our Roundtable discussion this month, we got some of the smartest investors we know to tell us where they'd put their money right now.

Among other things, we got some intriguing currency trades, some small caps with massive potential and a few nicely contrarian property plays. I'll certainly be looking at adding some of their tips to my own portfolio - you can read them for yourself in the latest edition of MoneyWeek, out on Thursday (if you're not already a subscriber, you can subscribe to MoneyWeek magazine).

Sovereign debt: one of next year's big issues

But getting back to potential tripwires, they all agreed that one of the key issues next year is almost certain to be sovereign default. This sounds outlandish, but countries effectively 'going bust' has been a time-honoured tradition following banking crises, reckons Kenneth Rogoff, arguably one of the world's leading experts on these matters.

That may or may not include a developed economy. Only this morning, The Telegraph reports that credit rating agency Fitch has issued another warning to various indebted European countries, including our own.

"The UK, Spain, and France must articulate credible fiscal consolidation programmes over the coming year, given the budgetary challenges they face in stabilising public debt. Failure to do so will greatly intensify pressure on their sovereign ratings." In other words, if governments don't spell out how they're going to stop spending so much more than they raise in taxes, then they'll see their credit ratings fall.

That's not necessarily a disaster. Both Japan and Canada have suffered ratings cuts at various points in their past without imploding. But we currently live in a world where many people and companies are being largely kept afloat by low borrowing costs. If the cost of borrowing is pushed higher by rising government bond yields, that could trigger a double-dip recession.

Weak bank lending is making things worse

And then there's the vexed issue of bank lending. Some people argue that bank lending is weak because companies just don't want to borrow. Others say it's because banks are too scared of future losses and so are hoarding cash. But MoneyWeek regular James Ferguson of Pali International points out that one situation creates the other. "The drop in demand is precipitated by the drop in supply," says James. How does this happen? Well, because banks won't lend, asset values fall if there's less credit available, asset prices can't be bid up as high. That leaves the private sector in a fix. Companies see the value of their assets falling, while their liabilities the money they owe remain fixed. What's the logical answer for a company in this position? "To pay down its debt".

• Why UK property prices are going to fall 50%
• When it will be time to get back in and buy up half price property

Trouble is, that means any spare money goes to repaying debt, rather than expanding the business, which in turn makes economic growth very hard to come by. A very clear example of this is happening right now in Latvia, reports the Financial Times.

To cut a long story short, lending in Latvia was dominated by Swedish banks. They issued mortgages and the like to Latvian borrowers. When the credit bubble popped of course, they were left with massive bad debts. So naturally, they've stopped lending.

But the Latvian prime minister isn't too chuffed. His economy has shrunk by about 18% this year. Now he's warning Swedish banks to start lending or they will choke off the recovery. "Of course you can say that Latvians were borrowing irresponsibly but to borrow irresponsibly you need someone to lend irresponsibly. We had very easy credit in a very overheated economy. Now we have almost no credit in a very deep recession."

Sadly for him, we can't see the Swedish banks obliging. Latvia is an extreme example of course. But a similar danger still hangs over the likes of the US and the UK.

But there are still plenty of opportunities

But as we noted above, there are also plenty of opportunities. People talk about Armageddon being averted this year. But the end of the world was never going to happen. No matter how extreme the financial crash, life goes on. We all need to make a living.

One of our major themes for years has been the idea that global economic power is shifting from the West to the East. This notion now seems to have been embraced with gusto by mainstream pundits. But as often happens, when good ideas go mainstream they get taken to extremes. We're now constantly told that China will be the biggest economy in the world and we should all be getting our children to learn Mandarin.

We wouldn't be so quick to write off the West. Emerging markets will get a bigger chunk of the pie, which is great news, but it doesn't mean there's none left for us. Globalisation has its winners and losers, but it's not a zero-sum game.

Innovation is the key for the West

To us, one of the main ways forward as it always is will be through increased innovation leading to better, more productive use of our time and resources. Our regular share tipper Paul Hill wrote about this a few weeks ago in MoneyWeek magazine. China and emerging markets have the edge in terms of costs and growth potential. However, as Paul points out, the West still has an advantage in terms of research and having some of the best educational institutions in the world. To find out how you can profit, have a look at Paul's story here.

Healthcare and medicine are particularly exciting areas. Stem cell research got a boost this year as Barack Obama lifted a funding ban in the US. Swine flu thankfully didn't turn into a disaster, helped by the development of an H1N1 vaccine.

Of course, turning scientific advances into products that can actually be used, and which can turn a profit for companies, isn't easy. And with funding drying up in 2008, the last few years have been pretty brutal for small companies in the sector. I'll be looking at some of the more interesting biotech stocks still available on the market in the New Year. And my colleague Eoin Gleeson looked at ways to profit from medical breakthroughs earlier in the year .

There are plenty of other opportunities ahead, and our experts will be highlighting their tips for 2010 in MoneyWeek's first issue of the New Year, out on Friday January 8th. This is the last Money Morning email of 2009. Dominic, David and I hope you've enjoyed reading our thoughts and found them useful.

Have a great Christmas and New Year, and we'll be back on Tuesday 5th January.

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