— “The Financial World According to Inya” Column,
by Inya Ivkovic, MA

During its recent committee meeting, the Federal Reserve announced that it is time to shut off the government money taps, winding up most of the U.S. specialty liquidity programs and starting by shutting down currency swaps with most foreign central banks by February 1, 2010. At the time, the Fed did not even address the risk of inflation or hyperinflation in the short term. Thus, the expectation is that interest rates will remain at ultra-low levels close to zero for at least the first half of 2010, if not longer. Eventually, however, interest rates will have to go up if the economy finally starts growing at a faster pace.

That said, if the Fed effectively manages to shift gears at the end of January towards restrictive monetary environment, some economists expect that the U.S. GDP will register output between four percent and 4.5% next year. If that pans out — and we have some misgivings about such an overly optimistic forecast and having the mess in the labor market in mind — then the overwhelming advice would be to load up on small-caps.

In essence, lining up investors’ exposure to small-caps along the changes in business cycles usually means increasing holdings in small-caps during economic recovery times and restricting exposure during times of restrictive monetary policy. For true diversifiers across all asset classes, the exposure to small-caps should never be zero. Quite the contrary, in the next three to six months, it might be a good idea to increase exposure to small-caps in one’s portfolio.

But let us be clear on something. Investing in small-caps is risky mainly because it is quite an unpredictable asset class, despite numerous key factors potentially working to its advantage. If the third-quarter earnings and revenues are of any indication, each declining by 28% and 15%, respectively, small-caps could actually lag large-caps early in the New Year.

Another opinion shared by many economists is that large-caps will outperform small-caps in 2010, because the former group has greater exposure to international markets, which have recuperated much faster than the U.S. economy, while small companies are more involved in the domestic markets. Overall, this is true. However, we believe there are plenty of small-caps that also have exposure to foreign markets, although not on the same scale as large-caps. We do not expect exposure to foreign markets to be a huge factor for small-caps in the coming months. We believe what will make the difference are companies with an edge, those developing exciting proprietary technologies, operating in niche markets, growing fast and generating strong earnings. The third quarter of this year was a difficult one for small-caps, but the Russell 2000 Index has posted gains against the S&P 500 Index again in October and November. In our books, this is grounds for optimism about small-caps’ prospects in the New Year.

Another significant disadvantage that may adversely impact performance of small-caps in 2010 is their tendency to weigh more heavily in the financial and consumer discretionary sectors, both of which are not expected to offer stellar performances in the first quarter of next year. However, if solid economic data continue pushing through, the initial lag of those two sectors may be a short one. That being the case, larger pools of money, such as pension funds, may deem it appropriate to take additional risks in exchange for the returns that small-caps may offer next year.

When performing due diligence on small-caps, investors should pay close attention to what is going on in the credit markets, too. Credit spreads between high yield bonds and U.S. Treasuries have declined from 22% about a year ago to about 7.5%. However, the credit market specialists generally do not expect the spreads to keep on declining much further and that could spell trouble for small-caps.

Credit spreads are a useful gauge to determine the economy’s lending capacity. Generally speaking, it is difficult for small-caps to raise cash through equity or bond offerings. What happens more often is that small-caps have to go to the bank to get the money needed to fund their operations. So, if the credit is not readily available or if loans are offered at difficult terms, small-caps may find themselves in the unenviable situation of being operationally stuck and unable to move forward. This is where small-caps with strong balance sheets have a distinctive advantage over their counterparts burdened with debt and declining cash flows from operations.

As far as Lombardi Financial is concerned, there is no such thing as a bad time to buy small-caps. We like them, because small companies are innovative and proactive and are a vital part of the large engine driving the economy out of the downturn. This is why, even when the credit markets are tight, small-caps have no shortage of private investors looking for new ideas and places to put their money to good work.

— “Calling the Trend” Column, by George Leong, B.Comm.

As we shortly close off 2009 and move into 2010, we will be capping off the best year of stock market gains since 2003. However, after the performance in 2009, there is expected to be some hesitancy heading into 2010.

A way you can reduce the overall market risk is via the use of options. Though most option strategies tend to be a short-term in nature, there is an option strategy that is straightforward and makes sense for the long-term investor who wants to play the longer term on a certain budget.

Referred to as “Long Term Equity Anticipation Securities” (LEAPS), these are simply longer-term options with an expiry ranging from a minimum of nine months to a maximum of three years from the time of purchase. They can be purchased as calls or puts; however, I will focus on calls for the purpose of this article.

First traded on the Chicago Board of Exchange (CBOE) in 1990, LEAPS have become quite popular as an investment strategy.

LEAPS were originally developed to allow the more conservative investor a longer timeframe for carrying out their options strategy. And during the 19 years since surfacing, the use of LEAPS has become an integral part of portfolio strategies involving stocks, indices and currencies for both the institutional and retail investor.

What are the advantages?

1. Leverage:

The cash outlay for LEAPS is relatively cheap versus the capital that’s required for buying the underlying stock.

For example, an investor who is bullish on the long-term outlook of Intel Corp. (NASDAQ/INTC) is considering buying 1,000 shares, which, at the price of $19.63 as of December 21, would entail a cash outlay of $19,630.

For the small investor, the cash requirement is unrealistic. But, by purchasing LEAPS, he or she could buy the right, but not the obligation, to purchase 1,000 shares of Intel by buying 10 contracts of the Intel January 2012 $20 LEAPS. The cost of the transaction (excluding commissions) is $3,050 (10 contracts x 100 shares x $3.05 premium).

The 10 LEAPS entitle the investor to buy Intel at the $20.00 strike price at any time prior to the January 20, 2012 expiry date. If the shares of Intel do surge over the next several years as expected, then the strategy would prove beneficial.

Let’s take a look. If the shares of Intel increase to $30.00 by January 2012, the investor would generate pre-commission profits of $6,950 ($30.00 – $20.00 – $3.05 x 10 contracts x 100 shares). The breakeven price for the Intel LEAPS is $23.05 ($20.00 + $3.05 premium).

Also note that the investor could alternatively exercise the LEAPS, which would allow for the purchasing of 1,000 shares of Intel at the $85.00 strike price. This alternative would be chosen if the investor remained bullish on Intel, while also wanting to hold the stock in their portfolio.

2. Long-term

Due to their long-term nature, LEAPS afford investors more time for their option investment to pan out. An investor bullish on the long-term outlook for a stock may want to consider LEAPS.

For instance, take a look at U.S. PC-maker Dell Inc. (NASDAQ/DELL). In terms of stock performance, Dell has been one of the best performing stocks in recent years. Since its IPO in 1991, Dell has recorded seven stock splits.

In that period, the return on Dell shares has easily outperformed the S&P 500 by a wide margin. By using LEAPS, an investor would have made some significant gains on Dell.

The same could be said for other stocks, including Microsoft Corporation (NASDAQ/MSFT) and Cisco Systems Inc. (NASDAQ/CSCO).

3. Less Volatility

The price of an option is comprised of the intrinsic value and the time value component. Intrinsic value refers to the relation of the strike price to the market price of the stock. The time value portion of the price relates to the length of the option contract.

Without going into a theoretical explanation of time value, the only thing you need to understand is that LEAPS tend to erode slower than traditional short-term options. In other words, the price of LEAPS decline at a slower rate and is less volatile than shorter-term options.

For long-term investors, LEAPS can represent a viable investment.

LEAPS are widely available on U.S. stocks. For U.S.-listed LEAPS, refer to www.cbot.com.

Because options are inherently risky, I recommend speaking with an options specialist before considering a strategy.

— “Ahead of the Street” Column, by Mitchell Clark, B. Comm.

There is a lot of consensus building in the investment community about inflation, interest rates, the dollar and even the potential for the stock market to rollover again in the bottom half of 2010. The one thing that can happen when there is so much of a consensus is that something totally unexpected can come out of left field and derail the most thoughtful of expectations. Another financial crisis could develop at home or overseas. Government economic policies can move pretty fast when political tides change. Even geopolitical events can sideswipe the capital markets. That’s why I’m so uneasy about the beginning of the next decade.

The best way to play capital markets in 2010 is with a good defense. The stock market’s last hurrah is upon us and, over the coming quarters, anything could happen.

I’m not totally convinced that the dollar is as vulnerable as investors think it is. First, the U.S. dollar Index (which measures the U.S. dollar against a basket of the world’s most important currencies) has already dropped substantially since February this year. In fact, the drop has been tremendous and is the main reason why gold hit new records and the price of oil has stayed overly strong given its fundamentals. Sometimes, the markets get ahead of themselves and they move so quickly to discount the current fundamentals that expectations for the future too quickly become the reality of today.

In my mind, the U.S. dollar has already corrected against world currencies. All the news is already in the marketplace. This includes high government spending, high government and personal debt, a big increase to the money supply, etc. Like I say, the bad news is already in the market.

I remember during the Reagan era when many on Wall Street were predicting the collapse of the dollar, because government spending was out of control and so was the debt. While the dollar was under pressure, the collapse didn’t happen. It didn’t happen for the simple reason that there was still no other large country where the global marketplace could park its reserves. The same story is true today. Even though U.S. Treasuries don’t pay much in the way of interest, there isn’t another stable, mature place in which to invest.

Countries might consider investing in such fast-growing countries as China and India, but investment risk is just too high. Take China, for example. That country currently has an almost fixed currency pegged to the U.S. dollar, but is under increasing pressure to float it like other mature countries. This is a huge investment risk that prevents the renminbi from becoming a reserve currency. And, let’s not forget that it is a communist regime after all. As an investor in China, anything could happen to your money with the swipe of a pen in Beijing. At the end of the day, investment risk is just too high for countries to consider anything other than the U.S. dollar as their reserve currency. This won’t change for a very long time.

So, from my perspective, most expectations for the future in capital markets are already here. This means that 2010 is going to be a really wacky year. I’m certain of it.

— “Profit Confidential” Column, by Michael Lombardi, CFP, MBA

The biggest difficultly employed consumers will face in 2010 will be higher interest rates. The prime minister of Canada, Stephen Harper, said it best this weekend when he warned Canadians that the era of interest rates being low is coming to an end, that interest rates will rise in 2010 and that consumers should budget for higher interest costs. I think this warning should be heeded by most industrialized countries.

For companies, higher interest rates will not be that much of a threat in 2010. This past year can be defined as a period when the great majority of companies realigned their costs. In particular, payroll costs were slashed. Two years ago, I wrote about how the recession would make American companies more efficient again because they would focus on trimming costs and doing more with less. And this is what happened.

For the most part, corporate earnings surprised on the upside in 2009…a trend I believe will continue for 2010. If it were not for a high employment rate and a glut of foreclosed homes on the market, our economy would be booming.

So, looking into 2010, I’m actually looking for a good economic year. I do expect interest rates to rise, but that will affect consumers more than corporations.

But I’d like to warn about one wild card: The stock market. The market rally that we have enjoyed since March 2009 will undoubtedly come to an end in 2010. The questions will be: “How far will it cut into the ability for companies to raise public money in 2010?” and “How will it affect the financial services industry?”

Yes, I’m very worried about the stock market for 2010. (You will read more on that in my 2010 Stock Market Outlook, which will be released in the first few days of the New Year.) So that is my biggest economic fear for 2010: how a return of the bear market will affect the psychology of consumers and businesses.

Michael’s Personal Notes:

Ever hear the saying, “Been there, done that?” Well, that’s how I feel about gold bullion these days. While many late-comers to the gold bull market are nervous seeing gold prices soften this month, take heart. Gold bullion has often displayed characteristics of a seasonal commodity.

In the years 2004, 2005 and 2006, gold bullion prices always fell in the month of December, just like they have in December 2009. Only in 2007 and 2008 did gold prices rise in the month of December, but remember those years were “soft” years for the gold bull market.

Gold is up 23% this year. I know of many gold stocks that have risen in excess of 100% this year. A little profit-taking and a little correction, in my mind, are exactly what gold bullion needs right now.

Where the Market Stands:

You are not reading much about the annual stock market “Santa Claus Rally” in the business pages of the newspaper and on the Internet, but this market sure does look like it wants to close out the year on the upside. This morning, the Dow Jones Industrial Average opens at 10,464, which is about a hundred points away from the Dow Jones’ 2009 intraday high of 10,566.

For the year, the Dow Jones is up 19.2%. In the immediate term, I continue to be more bullish than bearish. I continue to see the move by the stock market from its March 2009 low as a rally within the confines of a general bear market. While most analysts have given up on the rally over the past two months (wrongly so), I have continued to believe that the bear will give us higher stock prices in an effort to lure more investors back into the market. That’s how bear markets work.

What He Said:

“Despite all my ‘yelling’ and ‘screaming’ about gold, I believe only a few of my readers and a small fraction of the general public have taken a position in gold. Why? Because gold’s not trendy…buying condominiums for investment is! If you are an investor, you need to seriously look at investing in gold stocks, because gold bullion prices will likely continue to rise.” Michael Lombardi in PROFIT CONFIDENTIAL, September, 21, 2005. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.