A View from the Switch - A Year-End Preview with Dan

Frishberg
By Mike Wazowski

It’s that time of year again, the time when commentators, pundits and, these days,
bloggers get to exercise their hindsight and look through the rearview mirror at the
steps and missteps of the previous twelve months.

But smart investors don’t spend much time looking backwards. So, on Christmas
Eve eve, as the year drew to a close, Dan “The Money Man” Frishberg invited his co-
host of the day, Chicago options and futures trader Jack Bouroudjian and special
guest, market analyst extraordinaire Elaine Garzarelli, president of Garzarelli
Research, Inc., to trade in their rearview mirrors for crystal balls and talk about
what they see coming down the road before them. So what did these masters of the
market see coming toward them?

According to the Money Man himself, there is still some short term danger ahead.
The market, which has been a somewhat lurching upward climb, may be in line for a
course correction shortly after the first of the year. For that reason he is exercising
caution and not jumping in to what still appears to be a strengthening market with
both feet just yet. But, over the longer haul, Frishberg is reading his Market X-rays
as showing continued strength and more buying opportunities down the pike.

The indices he is looking at are inching up but the immediate circumstances are
that demand is weakening and the number of companies participating in the rallies
is thinning, with a rising number of new lows, a circumstance Frishberg refers to as
a “Hindenburg omen.” But, he notes, looking beneath the surface figures, half of
what is being traded are closed-end bond funds and those are what predominate
among the instruments hitting new lows. Meanwhile stocks in solid companies are
not showing signs of a Hindenburg moment. This means the time to act is
approaching fast, before the herd, who are not looking at that, begin to notice. So,
medium term, things are looking good.

And, although Frishberg is mainly focused on American prospects, he is also seeing

some beneficial signals coming from overseas. In particular he points to the recent
easing of tension on the Korean Peninsula where, if things go on as they have been
in the past week or so, the North Koreans show signs of putting down their sabers
after rattling them for most of the fall, even indicating in informal talks with New
Mexico Gov. Bill Richardson, that they may be ready to allow nuclear inspectors
back into their country. After the dust settles from the current technical
uncertainties, he is looking favorably at moving into the South Korean ETF, EWY,
which he called “very attractive” for the medium term.

From his view from inside the Loop Jack Bouroudjian is seeing options traders
showing a tremendous optimism, with very little put-buying (traders betting on the
markets going down) and what he called an “extreme amount of call-option buying
[betting on the markets going up] in Chicago”. According to his interpretation, even
before the November election professional futures traders like himself began
getting the feeling that the political pendulum is swinging back toward a more pro-
business bent and Pres. Obama shifting to the center from what many saw as a
heavy lean to the left in the first half of his first term in office.

Adding to that he said the markets had already factored in the big Republican win in
the midterm elections – a prediction that did not disappoint as it would have if it had
not come to pass. The good feelings and higher expectations since then, he
ascribes to a “Honeymoon Rally” by traders relieved by the extension of tax rates
from the Bush reductions. Of course, reading the financial tea leaves always
involves some risk – the ones Bouroudjian sees are if job creation does not keep
pace and improve in the coming months or if we get $90-a-barrel oil, since
sustained higher prices act as a tax. The unresolved question is whether the recent
spike in these highs is justified or if they simply reflect speculators looking to make
a fast buck.

Dan Frishberg sees this as part of a longer term trend he has talking about this for a
long time: with the global economy growing at a rate of around 6 percent, the
global middle class, especially in Asia and Latin America, is growing, There is simply
not enough capacity in the supply of natural resources and the transportation
infrastructure to meet the increasing demand of consumer and tech goods around
the world. So these resources will inevitably be rationed by price.

At the same time Bouroudjian did issue a warning about the coming danger of
stressed local government coffers. Defaults in municipal bonds could amount to
hundreds of millions of dollars in losses. While these tax-sheltered bonds had
traditionally had been very safe, he recommends that investors consider seeking
protection from these assets until the municipalities are get past their serious fiscal
problems. That, most anyone can foresee will only happen when the economy has
recovered to the point that tax receipts return to pre-recession levels and they
straighten out their pension problems.

For his part Frishberg points out that even bonds issued by cities that are not going
to default, and so are relatively safe, their yields will remain the same while the
market yields are going up, making the relative value of these assets go down. In
that case the only way to get your money out of it and put it into something more
productive is to sell them for less than they are selling for right now.

Elaine Garzarelli is one of the most successful people on Wall St. at predicting
market turns, including the 1987 crash and its turn-around point, the 1990 bear
market (and it’s end in September of that year) and the 2000 bear market in May of
that year. She uses four indicators to make her forecasts – the economic cycle,
monetary policy, valuation, and investor sentiment. Of those, only the last is
pointing downward, while the other three are bullish, giving her an overall read of
71 percent. She says “they’d have to drop to 30 percent for a major bear market to
begin again.” Several pieces of bad news would have to converge for that to
happen: industrial production, which is growing at 6 percent now would have to
drop below zero and we’d have to have the Fed would need to tighten the Fed
Funds rate by over 200 basis points. That would bring interest rates close to the
S&P 500 dividend yield, creating a situation in which the stock market would be
competitive to cash positions. But those are not likely to happen. Historically, she
notes when we’ve had a slow recovery – as this one has been -- they’ve lasted for a
number of years. Her conclusion is that the cyclical bull market is likely to last for a
long time.

As for a near term correction, she says in general when sentiment is as bad as it is
right now it points to a coming 4-7 percent correction. “I would expect any
correction,” Garzarelli told listeners to Radio Wall St.: The Money Man Report, “to
not be on the order of the 10-15 percent correction that followed QE [Qualitative
Easing]1 stopping in the spring but a lot less.” Generally, she added, these
corrections last 3 to 4 weeks.

Garzarelli is expecting around 3 percent growth in the overall economy for 2011.
The sectors that she sees with the best potential to keep growing through 2013 are
the consumer durables, the industrial and transportation equipment and software
area, and net exports. These sectors, she says, should start to outperform real GDP
and therefore earnings will outperform the S&P. She also sees residential
construction, fueled by favorable mortgage rates and increasing consumer
confidence, as well as consumer wealth, which has increased 20 percent in the last
year, along with the inexorable growth in population, all resulting in increased
demand for new homes in the next three to five years.

What she would veer away from are the counter-cyclical, such as utilities, consumer
staples and health care, three areas she sees as not growing as fast over the
coming year or so, although they are going up right now while the cyclical sectors
are going through the correction right now.

So that is what three of the smartest people you can listen to are seeing coming
down the road. You can catch a ride with them or just go on traveling in the same
direction as everybody else. But then, by the time that everybody catches up, the
leaders have already moved on. That’s why some people drive Fords on the road of
life while others sit in the back of stretch Lincolns.