The strong performance of the market since March ’09 has pushed many institutional investors to step back into stocks. Now that we are back to pre-Lehman market levels, investors seem divided about what the market next move will be.

I believe there are two possible outcomes for the year. As you will see even the brightest and smartest investors disagree:

It is the bullish theory: Axel Laroza, managing director at Lazard Freres Gestion explained it very in a recent article in Les Echos.

 Institutional investors are still way under-invested in equities and will have to keep buying stock in order to adjust that.

Companies have cut their investment and destocked so much in 2009 that they will have to adjust their inventories level, which will immediately boost economic growth and stock markets’ expectations at the same time.

Central banks are so concerned about deflation that they will keep interest rates low for quite a while.  Equities will remain the best asset class to invest in for the best part of 2010. Strong flow of money in the stock markets will push markets higher.

M&A will reappear as companies’ valuations are still low given the economic recovery around the world. 2010 will bring record deal on the table and will push markets higher too.

Here is the bearish theory: it is more or less the view of the most pessimist like Denis Kessler, Scor CEO.

Unemployment is at 10% in most of the G7 countries and even if Japan is much lower its unemployment level is at its highest in more than 50 years. These levels will worsen or remain stable for the best part of 2010. Consumption will not rebound in developed countries.

Countries’ debt is at very high levels. It has never happened in the past and it raises many concerns about the governments’ ability to decrease their debt levels. They will either have to hope for strong economic recovery the next two years or have to raise tax rates and push inflation way up. Either way inflation will be detrimental to sustainable stock recovery.

Countries’ debt levels are also a concern in case the global economic does not recover as quickly as expected. Governments, already too indebted,  will have no flexibility to come up with more facilitating monetary policies.

Expected growth of less than 2% in France for exemple, 1.4% for 2010, is not enough for companies to start hiring again. What if growth rate do not get to the 2% level for another few years?

Companies are experiencing the same inventories and debt reduction Japanese companies’ face in the 1990’s. If it is true it is just the beginning of a lost decade for the stock market.

Both scenarios are possible. I am more in favour of the second one. I don’t expect China to be the savior again in 2010. China is also facing the start of a bubble and they have to act fast before it is too late to prevent it. As a result China will have to implement tougher fiscal and monetary policy. The government will be more concerned about its domestic economy than helping the rest of the world. The absence of China on the international will be a prejudice for global economic recovery. If that happens, as I expect, the second scenario will take place and a second leg of the 2007 recession will emerge.

I am concern analysts tend to forget about macroeconomic issues. They seem to be certain we are experiencing a typical economic recovery. Historically when that has happened stock markets have enjoyed five year of strong growth. When I look at what is going on right now I am a little cautious about the wave of optimism.

I hope this will help you make up your own mind for 2010.

Sony (6758 JP) had a conference a few days ago at the Consumer Electronics Show. At first glance I would say there are very few new features. Mostly there are upgrades of the existing line-up of products.

The most important news is the expansion of the Playstation Network offering with a commitment to have 2700 movies and 16000 TV episodes available. It was only respectively 300 and 1200 in the past. The services have expanded into Europe and as of today there are 38 million users for about 780 million pieces of content.

Other than that, Sony has announced few adjustments with the arrival of a 3-D TV in option on the new Bravia TVs. New TVs will be available from 22-60” with a majority of the models including LED backlighting and wireless connectivity. Sony has decided to change the name of the series from “X-series” to “Signature” and “Cinema” for a better appeal to customer. We will see how consumers reacts to this change but I think it should be beneficial.

There will be a new Blu-Ray players (from PS3 to 400-disk megachanger) and home theater audio systems (with monolithic design). Sony has developed a new 3 pounds VAIO PC (Type Z) and has come up with one PC made of recycled materials (Type F).

Overall the conference was disappointing with no new features. The management seems also unsure of itself. I don’t expect the stock price to really outperformance its sector. However, if other technology companies release interesting results and products, Sony could benefit from the investors’ willingness to buy technology stocks.

Japan is heading back to the 1990’s when deflation stopped government to come up with enough tools to boost the Nippon economy.

In October the headline CPI fell 2,5% yoy and the underlying deflation (excluding food and energy) is comparable to the 2001 levels a period of real crisis in Japan. The perspective are for the moment positive since economists expect a lull if we take in consideration that the impact of the commodity prices fall over the past year is behind us.

Macquarie deflation risk indicator (based on the IMF methodology) indicates a situation as bas as a decade ago. The IMF methodology is based on four relevant areas: aggregate prices, measures of excess capacity, asset markets, and credit and monetary indicators.

The issue with deflation is that government cannot use monetary policy anymore since interest rates are already near the 0% level. It was Japan’s case for years in the 1990’s. For example recently central bankers in Europe and US were able to end the recession using a quantitative monetary policy (interest rate almost at 0%) but in case of deflation this strategy will have no effect. We understand now the reason why Mr. Bernanke and Mr. Trichet keep interest low for a long period of time … hoping to push people to consume today and push prices up bringing back inflation.

Japan’s central bank did not have the luxury to be able to decrease its interest rate since it was already near 0% and that is a problem. It seems the government did not prevent deflation to reappear and today the situation worries many economists. Even the government has declared recently that deflation should be around for the next few years. The period of the 1990’s was terrible for a generation of Japanese so the thought of a new period of deflation would be devastating on the new generation.

The Japanese government seems unwilling to do anything about it. At the same time we are talking about a government that claimed for years that Deflation was not a problem for its economy. Sometimes it makes me wonder if they really understand what is at stake. Maybe the politics are so fed up with this situation that they don’t believe they can opt out of it.

Anyway, the reality is that except pouring liquidity in the market, like the promised ¥10 trillion to face the Dubai debacle, the government does not have any other tool to get out deflation. When we know that Japan is already the more indebted economy of the G7 countries it makes us wonder if this strategy will work much longer.

If deflation is really here for the next three years, then the Japanese domestic economy will be again in the dark. The Japanese stock market will be driven by exporters once again. If, like I believe, world economic growth will be slow in the coming years, then Japan is entering another rough period.