Financial markets enter 2011 with many investors persuaded that the world economy is on the mend and that riskier assets such as stocks are set to do well.
Data from Reuters asset allocation polls and State Street's investor confidence index suggest investors are positioned for more stock gains and a continued move away from supposedly safer assets such as government bonds and low-yielding cash.
The Reuters polls, for example, showed equity holdings among leading investors at a 10-month high in December, while State Street's index for the month moved into bullish territory for the first time since March.
But the waning days of 2010 suggest investors will almost immediately have to face three major risks to their rather bullish mood. In no particular order, those are: China's trade, America's economy and the fate of billions of dollars pumped into benchmark government bonds.
Of the three, the pace of recovery in the US economy will be most clearly on display, with monthly US jobs data due to be released on January 7.
It may take on extra importance this month as much of the change in investors' appetite for risk has come about as signs have increased that the US slowdown in mid-2010 was only temporary.
US equities, for example, have recovered to the extent that the over-the-counter Nasdaq index has actually outperformed much-touted emerging market stocks, as measured by MSCI.
US equities have been among the big winners since Federal Reserve Chairman Ben Bernanke made clear in August that the Fed would buy more assets to boost liquidity in the US economy.
The S&P 500 index, for example, is up around 20 percent since his Jackson Hole August 27 speech.
So any sign that the US economy is not recovering as thought could cause an early reversal.
A not-unrelated worry is the Treasury market, which has been hit by a combination of rising prices for riskier assets, the impact of tax cuts on the already large US deficit, and a general feeling that bonds may be overbought.
The past few weeks have seen a few days of large sell-offs, including one following dismal demand at an auction for five-year paper.
An orderly sell-off of bonds would not unduly worry investors and would fit with their scenario of rising "risk" assets.
Were Treasuries and other benchmark bonds such as Bunds to sell off too sharply, however, significantly higher yields would unsettle investors and have the reverse impact on liquidity than that sought after by the Fed and various other authorities.
Reuters latest polls on expected bond yields found a median projection of 3.40 percent for US Treasuries around a year from now. The yield has already revisited those levels this week.
The third risk that investors may face in the coming week is China's decision to cut its export quotas for rare earth minerals by 35 percent for the first half of 2011 versus a year ago.
Rare earth minerals are used in a range of products from MP3 players and computer hard drives to hybrid cars, wind turbines, light bulbs and coffee makers.
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