The surprise Republican victory of Massachusetts Senator Scott Brown gives the GOP 41 votes and changes the game on Capitol Hill, as the Democrats have lost their super majority in the Senate.  All eyes are focused now on how this news may delay or torpedo Healthcare reform, with the consensus that financial reform will move up to the top of the list if Healthcare goes into cardiac arrest.  Before you get too excited that the shift to the right in the Senate could shelve financial reform, it is unlikely that the OTC derivative portion of the reform is going to go away as there is bi-partisan consensus that regulation is required.  More likely, the sweeping financial reform goals would be slimmed down with issues like the Consumer Protection Agency, taxing banks and creating a new bank regulatory body being brought into question.

On the OTC derivative reform, there are still two major steps that need to happen on the Senate side.  First, Senate Agriculture Chairman Blanche Lincoln (D-AR) is putting together her own bill.  Meanwhile, retiring Senator Christopher Dodd (D-CT), Chairman of the Senate Banking Committee, is trying a bi-partisan approach of having Senator Judd Gregg (R-NH) and Senator Jack Reed (D-RI) work on the derivatives portion of his sweeping financial reform bill proposed this past December.  Senator Gregg has been an outspoken supporter of not penalizing non-financial corporate end-users of derivatives while Senator Reed’s bill did not recognize any end-user exemptions. Reed also has been a proponent of as much clearing and exchange trading as possible. 

The message from voters is dissatisfaction with progress, despite the massive amounts of money being thrown at the various problems.  So while the Right may have moved the needle to have less regulation, Main Street voters are still not happy with Wall Street, and the financial reform will have to be passed soon so that Democrats up for re-election this fall can tout something.

Although nothing in this world is said to be certain except death and taxes, it is that time of year when everyone makes their 2010 market predictions, despite the fact that most predictions are dreadfully wrong.

Whether it is an industry prediction:

‘No one will need more than 637 kb of memory for a personal computer—640K ought to be enough for anybody,’ Bill Gates, Microsoft, 1981.

Or an economic prediction:

You don’t have to look far to find a bad forecast or prediction, which is probably why little time is spent going over how accurate the previous New Year predictions have been. 

But I can’t do a New Year’s blog without one, so my one and only 2010 prediction is this: “Something dramatically unpredictable will happen in the markets that will give treasurers another headache.” The thing is, will treasurers have hedged against it?

If there is one thing that the financial crisis should have taught us is that you cannot predict the markets, and volatility can come hard and fast when you least want it. One-in-100-year events were happening every week during the crisis, and prices moved by more than two standard deviations during a lunch break. 

It’s easy to start looking at current indicators and trends and to take the most obvious and assume the opposite could happen.  Maybe this is happening already, starting with the US Dollar, which everyone has said should be worth a lot less but which has spiked in recent weeks.  The stock market bears, including yours truly, have all gone into hibernation now with the market roaring out of the gates on the first trading day of the year.  Most now feel that a double dip recession is not going to happen…so what if it does?

Bottom line is: unless you are Warren Buffett, it’s foolish to forecast the market, and the best bet is to hedge against some worst case scenarios.  I would continue to argue that options are the best product for this strategy as you can buy way out of the money options in the unlikely event that something catastrophic does happen.  Unfortunately, many companies still have a tough time getting an option expense budget approved.   Volatility has actually dropped, so options are looking more affordable, and again, if my prediction is correct, it will be too late and too expensive to hedge when the “Black Swan” does splash down somewhere, sometime in 2010.

Actually, let me make one more prediction: taxes are certainly going to go up.

Happy New Year!

1 From an the article “Technology Predictions Are Mostly Bunk” by Gordon Crovitz, Wall Street Journal, Dec 27, 2009 http://online.wsj.com/article/SB10001424052748704039704574616401913653862.html