April 2010 Issue: Key Points

The past two months have seen a sharp escalation in news coverage about the future of China, with sharp disagreement about whether that country will soon face a collapse of epic proportion with highly unpredictable results for world politics and economics, or whether the leadership of the Chinese Communist Party will be able to muddle through, avoid collapse, and gradually transition the nation to higher levels of private consumption spending and much lower dependence on export and investment led growth. Since this issue is central to investors' portfolio risk management decisions, this month, in place of our usual broad review, this month we present and evaluate the conflicting evidence regarding the future of China.

We find that the weight of evidence suggests that a serious crisis in China will probably occur within the next three years. However, the timing of that crisis remains uncertain; with a leadership transition due in 2012, we believe that the Chinese Communist Party will try its best to forestall its arrival until after a new President and Premier is in place. That said, events outside of China -- such as the enactment of trade sanctions by a U.S. government frustrated by continuing high unemployment -- may trigger a crisis before 2012. We also find that the outcome of the current competition between two key CCP factions -- known as the Princelings and the China Youth League -- will probably have a very strong impact on the way the almost inevitable crisis will play out. The former group appears to be counting on a return to a populist version of Maoism will enable them to weather the storm and retain legitimacy as the rightful rulers of the nation. In contrast, the latter's recent behavior leads us to conclude that they seem more likely to rely on nationalism and external conflict as the means of retaining their legitimacy and power. We conclude with a view of the asset allocation implications of our analysis.

| Product and Strategy Notes: State Street's Filed -US ETF "IBND", Claymore's "WFVK"; Investing in Bond Indexes; New Paper - Sharing Longevity Risk - A Must Read | Overview of Our Valuation Methodology | Uncorrelated Alpha Strategies Detail | Global Asset Class Returns | Global Asset Class Valuation Updates Detail through March 31, 2010 | Table: Market Implied Regime Expectations and Three Year Return Forecast | This Month's Letters to the Editor: How Can a Retail Investor Access Volatility? Clarification of "Return Momentum" | Table: Fundamental Asset Class Valuation and Recent Return Momentum | April 2010 Issue: Key Points | Investor Herding Risk Analysis | Feature Article: What Lies Ahead for China? |