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Goldman Sachs recently issued their 2010 investment outlook.  In addition to being bullish into year-end, they are quite bullish heading into the new year as we transition from “hope” to “growth”.  They see many similarities between the current market environment and 2004 when investors were still doubtful of a recovery, but strong earnings growth powered markets to further gains.

Based on this bullish outlook their top trades are built around three primary macro themes:

1.  Accommodative global central bank policies.

2.  The expansionary setting of economic policies.

3.  The growing gap between emerging economies and developed nations.

Trade #1: Short volatility – With the VIX trading in the low to mid 20’s Goldman sees an opportunity for more downside as the economy continues to normalize and investors become less skittish.  The VIX has historically traded in the 15-17 range and Goldman sees a return to this level.

Top trade #2: Long Russia -  Despite robust growth Russin equity markets have lagged returns in the region.   They see 25% upside in 2010 as investors reallocate into Russian equities and growth remains robust.

Top trade #3: Short NZD/Long GBP -  Growth in Europe will continue to surprise to the upside which should support Sterling.  In addition, they see the New Zealand government pressuring their currency as well as slower rate increases than the consensus expects.  They see 13% upside in this trade.

Top trade #4: Pay 2-yr UK Rates vs. Australia 1-yr Forward at -268.5bp, target -150bp  – Goldman believes the rates are likely to rise faster in the UK when compared to Australia, than the market is currently pricing in.

Top trade #5: CDS convergence between Spain and Ireland -  The real estate busts in Ireland and Spain have been devastating.  Despite a much more proactive government response, better prospects for paying down debt and higher potential economic growth, Ireland’s 5y CDS remain substantially higher than Spain’s.  Goldman sees further room for narrowing.

Top trade #6: buy the currency growth basket -  Goldman shows that currencies are sensitive to the rate at which the output gap closes. At this early stage in recovery growth differentiation strategies thrive.   The FX Growth Current currently contains long positions in INR, IDR, CNY, AUD, PLN, PHP and short positions in MXN, RUB, TRY, TWD, HUF, MYR.

Top trade #7: Long PLN/short JPY -  The Polish currency is 14% undervalued compared to the Euro and robust economic growth should provide room for upside.  The Yen on the other hand is significantly overvalued.  Goldman sees the poor fiscal condition in Japan and government intervention capping upside on the Yen.