Saxo Bank says the improvement in financial markets last year and into 2010 is no more real than the speculative boom of 2003-2006 that was based on cheap money, but is bullish for the coming 12 months because many investors will think recovery is real and put money to work.

“In our view, we have now entered the third of the major credit-induced expansions since the mid-1990s,” the bank said in a strategy note.

The first expansion, from 1994 to 2000, was fuelled by economic deregulation and the willingness of the US Federal Reserve to handle any major stock market pullbacks with cuts in interest rates, the Denmark-headquartered bank said. The second, from 2003 to the start of the credit crunch, was driven by record-low interest rates and consumer spending, and the third phase, starting in 2009, is driven not just by very low interest rates but also by large government bailout programmes, it continued.

“Low interest rates have fostered wild and irresponsible speculation, over-investments and mal-investments. We have now reached a point where spare capacity is rampant in most industries and the debt burden is unserviceable, since income generation is stalling,” Saxo said.

Saxo said the boost to the huge stimuli packages will endure “well into 2010”, with almost all major asset markets enjoying a recovery, with the notable exception of US government bonds. “In other words, the government bonds market smells something fishy,” Saxo said, referring obliquely to concerns among bond investors that debt-laden governments may struggle to repay their obligations, or may reduce burdens via inflation.

Among the bank’s ten “top picks” for 2010 are a long position to be taken in German government bonds (bunds); Saxo argues inflation pressures and growth in Germany and the euro zone will be muted this year, which will bode well for government bond prices, which are currently pricing in a more upbeat economic outlook. Other picks include the trade of being long of TSE Small Caps, the Japanese sector, and being short of the Nikkei index. Saxo argues that small-cap Japanese firms are undervalued against their large-cap cousins on the Nikkei. As the yen weakens, as Saxo expects, small-cap stocks should fare well, it adds.