REVIEW OF VEGA PROGRAMS

Vega Equity* Program

While we were extremely cautions during the entire 2009, we still succeeded in capturing the significant portion of the upside in the market. You are receiving individual reports with this newsletter. It is rather obvious now that the FEAR in early 2009 gave way to GREED over most of the rest of 2009. Clearly the GREED leg has been stronger and longer than most analysts have anticipated. The willingness of the Federal Reserve to take huge risks with the balance sheet has been grossly underestimated.

Vega Safety Program

This has been extremely successful year for the program — probably the best year of this program. We have recovered all the losses even in high yield positions, and enjoyed a very significant increase in all fixed instruments in the portfolio. However, the upward pressure continues on benchmark yields in all the major bond markets. US Treasury yields increased the most, by 30 basis points along the yield curve — which is inversely proportional to bond prices. Supporting the upward shift was positive performance in equity markets, along with the decreasing implied volatilities with the VIX falling below the 20% mark.

Vega Inevitable Program

The program has been very successful in its first year of existence. The accounts in this program enjoyed significant appreciation due to the rise of prices of commodities (gold and silver especially), and other anti-inflationary instruments. We will continue to utilize this program to offset inevitable inflation of U.S. dollar, while utilizing more of technical trading instruments — protective puts and covered call to gain additional yield due to the inherent volatility of the market in these instruments.

OVERVIEW OF THE ECONOMY

Size of the Fed's balance sheet as of October 28, 2009 is up from $940 billion a little over a year ago to $2.2 TRILLION dollars.

As we all know, over the past year, the Federal Reserve has committed trillions of dollars to its extraordinary effort to shore up the financial markets and prevent a severe recession from turning into a depression. By all signs, and with help from the stimulus package, it is working. Credit is flowing, the economy is growing. What to do next? Fed has to tighten and get the "excess" money out of the system. The big question is how to do that without jeopardizing the fragile recovery, and giving the government ability to implement several multi-trillion programs.

Dubai is drowning in debt. Sheikh of Abu Dhabi has just spent $25 billion bailing out his profligate neighbor. Greece and Spain government bonds are at the default levels. There are many problems brewing in commercial real estate not only in the United States but in many countries around the world - and Dubai is just the beginning.

Unrealistic assumptions, layers of investors, sky-high prices and possible fraud will make it hard to clean up the mess in commercial real estate. Already, prices have plunged 41% from the peak in 2007, according to Moody's/REAL Commercial property Price Index. The amount of commercial real estate investments that didn't qualify for refinancing during the first 10 months of 2009 was $6.4 billions. $1.7 trillion is the total value of commercial loans on bank's books — roughly 25% of assets for the average institution.

In addition to the reported unemployment, about 26% of working Americans have "nonstandard" jobs. Out of these 26%, 13.2% are working fewer than 35 hours a week, 7.4% are independent contractors, 2.1% are temporary employees, and 2% are on-call.

While we have avoided a major catastrophe of financial institutions, we simply do not see signs of healthy recovery in 2010. Stabilization — yes, avoiding the depression — yes, but not yet a healthy recovery.

WHERE WE STAND

With everything said above, we think 2010 will see MORE GREED & JOY in the early part of the year (Q1), which will give way to FEAR over most of 2010 as the chickens come home to roost for the Debt Binge currently being undertaken.

Of course, not all sovereigns have bad and/or fast deteriorating balance sheets (as a result of highly risky fiscal and monetary paths). Core Europe, Norway, and Brazil all spring to mind. Elsewhere hard assets, most obviously — gold and even crude, will do extremely well. We expect crude to be up at $100 and gold up at $1500. We like commodities, and anything else that Bernanke can't print at the press of a button.

By the end of 2010 we may finally see huge buying opportunities. Our policymakers will keep taking risks until they break the back of the camel (the market), at which point bond yields and currencies go into a tailspin, causing massive pain in the domestic economy. This will ultimately mean a much longer period of forced austerity (higher taxes, higher savings, etc).

Tactical Positioning:

The 1120 resistance in S&P500 is now properly broken so the next leg should be higher. We are looking for 1225 level for S&P500, tighter credit, flat to weaker bonds (approximately 4% for 10-year Treasuries).

However, as late Q1 unfolds and into Q2, the reality of the dire economic situation will become clear (no sustained private sector demand) and at that point all the noises from policymakers re Exit Policies and Fiscal Rectitude will be seen by the market as — well — just noise. Policymaker credibility will crater as they are then forced to reverse their Exit/Rectitude talk.

Strategic Positioning:

The belly of 2010 (Q2, Q3) is when we expect to see the play out of the next phase of FEAR, driven by the issues discussed above. The key drivers will be fear and panic around unsustainable debt paths vs. ongoing Private Sector deleveraging and a lack of sustainable final demand ex-Govt largesse, the collapse in policymaker credibility, ratings events, and overall significant spike higher in bond rates.

The inevitable reality however is that austerity is coming, whether we like it or not. In our equity portfolios, we will overweight companies with strong balance sheets, will diversify internationally, and across the sectors, and will favor larger companies with large dividends.

In the fixed income accounts, following a fantastic year in 2009, the return prospects for bond investors in 2010 look somewhat less radiant. As central banks start to normalize monetary conditions, there is likely to be a re-pricing of government bonds. In general, yields across all maturities can be expected to shift upwards in 2010, denting fixed income assets' performance over the year. At the same time, following last year's dramatic tightening, credit spreads have reached levels threat are closer to fundamentals.

We will focus on short to medium term maturities, avoiding government bonds. We believe that high yield bonds will continue to outperform investment grade bonds in 2010 as the default rates decrease. Investors should expect moderate returns both for investment grade and high yield bonds in 2010 — but not the same as in 2009.

A DOSE OF REALISM

Investors shouldn't get carried away. 2010 is likely to be a year of policy change and uncertainty about exit strategies from the loose monetary policies and the commitment to long-term fiscal sustainability and it will give investors cause for concern. Moreover, global equity markets can no longer rely on declining risk premiums to drive returns. Stronger earnings growth is, to some extent, already discounted in current valuations, suggesting a year of more modest gains ahead.

We still believe, however, that equity markets might provide a meaningful return in 2010.

As always, we appreciate having you as clients, appreciate your trust in us and welcome phone calls/e-mails with any questions you might have. Please, set up a meeting with us to review your portfolio for possible changes in your portfolio allocation.

Vega Capital Group Team.