August 5, 2013

Economic and Market Recap The U.S. economy is on a slow grind up. Wed all like to see faster growth, but steady improvement along with Federal Reserve support has boosted investor expectations. This has led to an expansion in the S&P 500 TTM valuation that accounts for about 75% of the price improvement in the index in the last couple of years. This wouldnt be so much of a concern except that the valuation is now reaching historic levels consistent with a reversal in the valuation. The concern is that the reversal (decline) can only occur with a reduction in the numerator (the price of the index) as corporate earnings are showing decreasing momentum. For that reason, investors need to have realistic expectations for future growth.

L a n e A s s e t M a n age m e n t
Stock Market Commentary
Further good news came when the Empire State Factory Index of Business Conditions greatly exceeded expectations (the index has a strong correlation to GDP) and shortly thereafter, the Philadelphia Fed Business Conditions report hit a 2-year high. Along with generally better-than-expected corporate earnings (against reduced expectations, mind you), the S&P 500, the Dow and the Russell 2000 all hit all time highs while the NASDAQ 100 rose to its highest point since October 2000. As the month entered its final week, the weight of mixed earnings reports and more modest reports on top line growth cooled the markets advance. Europe also got a boost when European finance ministers agreed to extend the Greek bailout, recovering from a 5% decline in June, but still well below its prerecession high (and still below its more recent high in April 2011). Europe manufacturing improved for the first time in two years. Investment Outlook The S&P 500 with reinvested dividends (SPY) has advanced about 40% since the beginning of 2012 and over 20% since the beginning of this year, most of this on account of expansion in the PE multiple. The major indexes are reaching multiyear if not all-time highs. Meanwhile, market valuations are becoming stretched to historic levels (see side bar). Im not ready to run for the hills quite yet, but I do advise caution, especially if an equity market correction of 10-15% would be unacceptable. In terms of equity participation, I suggest:

Since the weakness in SPY that was triggered by Bernankes May comments about possible Fed tapering starting relatively soon, and then his (and other Fed governors) backpedal to say that nothing has really changed, SPY has improved nearly 9% without interruption and has reached new all-time highs. In addition to relieved expectations about Fed tapering, July got off to a good start with strong consumer spending, especially on motor vehicles, and a better-than-expected payroll report while chain store sales improved to a record high.

Increase exposure to safer, stronger U.S. sectors like consumer goods and health care Increase exposure to strong dividend payers.

As for bonds and other income investments, I recommend keeping durations short and expected returns low.
The charts on this and the following pages use exchange-traded funds (ETFs) rather than market indexes since indexes cannot be invested in directly. The ETFs are chosen to be as close as possible to the performance of the indexes while representing a realistic investment opportunity. Prospectuses for these ETFs can be found with an internet search on their symbol. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
S&P 500
July (and the first days of August) was another interesting period, technically speaking:

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SPY managed to break through resistance at $166.29 after several prior failures. This is usually seen as a SPY has broken away from its 50-day moving average (50DMA) trend line, another strength move as you

good indication of continuing positive trend.

can see in prior times (e.g., near the end of February and the middle of April). Keep in mind, though, that such breakaways dont tend to last long.

Momentum indicators overcame their negative bent in June and, once the direction reversed, it extended itself in normal fashion.

Despite this positive turn of events, prompted, Im sure, by Bernanke backpedaling on his earlier suggestion of a potential near-term wind down of the Feds asset purchase program (an element, along with managing the Fed funds rate to near zero, of its QE program), the re are other signs that arent quite so promising. Most concerning is that the S&P 500 market valuation is becoming further stretched on both a 12 trailing month (TTM) and Shiller (normalized 10-year) PE basis. Second quarter earnings results are coming in ahead of expectations, but those expectations had been downplayed. For revenue growth, the picture is much more mixed. Also concerning is the longer term trend chart shown on the right hand side of the next page. With SPY up over 25% in the past 12 months, were likely to be in a yellow flag mode for a while.

SPY is an exchange-traded fund designed to match the experience of the S&P 500 index adjusted for dividend reinvestment. Its prospectus can be found online. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
S&P 500 Trend
Below we have two pictures of trend in SPYs price. On the left, we have a shorter term, daily view with a spread from the top of the channel to the bottom of about 7%. In this view, SPY recovered quickly from a breakdown that occurred in late June (which I had thought would lead to further deterioration at the time). At the moment, this trend is generally positive with price below the midpoint and rising.

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On the right, we have a longer term, weekly view with a spread from the top of the channel to the bottom of about 17%. In this view, SPY is at the top of the channel for the 5th time, with 2 out of 4 of the prior times resulting in a correction to the bottom of the channel. As we may be looking at a repeat of the pattern that occurred in the spring of 2011, this chart is more worrisome, especially when combined with the knowledge of the stretch in the market valuation (S&P 500 PE ratios). Also, it should be noted, that longer term trends are generally more reliable indicators of repeating patterns. Notice how price doesnt linger long at the top (or bottom) of the channel.

SPY is an exchange-traded fund designed to match the experience of the S&P 500 index adjusted for dividend reinvestment. Its prospectus can be found online. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
All-world (ex U.S.)
International equities, represented here by VEU, are showing characteristic volatility with a rapid recovery from the breakdown that occurred in June. VEU is now breaking above resistance at $46.35 and this may becoming a new basis of support. This pattern is fairly consistent among the various regions of the world. Technically, when the momentum shifted to positive in the early part of July, that gave a reliable indica-

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tion of price recovery of some amount though Im not sure a full recovery could have been anticipated on purely a technical b asis. On a fundamental basis, Europe seems to be digging its way out of recession and that news has lifted the Euro Zone to be the one region showing new 12month highs as measured by region-specific ETFs. Europe still has a long way to go to reach its prerecession highs, a fact that might be taken as a positive indicator suggesting there is room to run as the fundamentals improve. My bottom line is that the broader international sector is not showing enough consistent momentum to give me investing confidence. Europe, on the other hand, especially certain selected EZ countries, may be a place to add some exposure.

VEU is an exchange-traded fund designed to match the experience of the FTSE All-world (ex U.S.) Index. Its prospectus can be found online. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
Asset Allocation and Relative Performance
Asset allocation is the mechanism investors use to enhance gains and reduce volatility over the long term. Commonly, investors

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choose an allocation that reflects their risk tolerance and reallocate at prescribed times, say, semi-annually, or when the actual percentage allocation deviates from the longer-term strategic plan. One useful tool Ive found for establishing and revising asset allocation comes from observing the relative performance of major asset sectors (and within sectors, as well). The charts below show the relative performance of the S&P 500 (SPY) to an investment grade corporate bond index (LQD) on the left, and SPY to a Vanguard Allworld (ex U.S.) index fund (VEU) on the right. Domestic equities continue to outperform investment grade corporate bonds on a relative basis. While fluctuation in the relationship is likely to be volatile over the coming months as the Fed works its way into its tapering mode, I expect the underlying trend to continue. On the right, the domestic overbought situation I referred to last month did reverse itself. Meanwhile, we have a little bit of a mixed message today with domestic equities still out performing the broader international group represented by VEU while a bit of a reversal began in July. As indicated on the prior page, I see little to motivate me to chase the broader index, although certain regions, like the EZ, and certain countries, like Germany and Belgium, are beginning to look a little more promising.

SPY, VEU, and LQD are exchange-traded funds designed to match the experience of the S&P 500, (with dividends), the FTSE All-world (ex US) index, and the iBoxx Investment Grade Corporate Bond Index, respectively. Their prospectuses can be found online. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
U.S. Corporate Bonds and Preferred Stocks
LQD represents the total return (capital gains and interest income) for investment grade corporate bonds; PFF represents the total return of the S&P U.S. Preferred Stock index. Regular readers know that I have been very positive toward investment grade corporate bonds for a long time as even hiccups have turned out to be brief interruptions to a continuing upward trend. In the past, I have not been concerned about the prospect of slowly increasing interest rates since I expected

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the turnover of bonds to those with higher yields to offset, at least somewhat, the impact of rising rates on the portfolio. Well, that was then and this is now...and slowly increasing interest rates are not what weve experienced with the 10-year Treasury rate increasing over 50% from the end of May to the beginning of July (more or less stable since then). See the next page. Accordingly, Ive become much more selective with regard to income-oriented investments. Given the uncertainty regarding future investor reaction to rising rates, I would look for other incomeoriented opportunities rather than conventional bonds at this time. One of those areas is preferred stocks and the chart on the right below shows a continuing underperformance of LQD relative to PFF. There are other alternatives, including so-called senior bank loans with floating rates and short term high yield bonds. The choices are complex and thorough research is recommended.

PFF is an exchange-traded fund (ETF) designed to match the experience of the S&P U.S. Preferred Stock index. LQD is an ETF designed to match the experience of the iBoxx Investment Grade Corporate Bond Index. Prospectuses can be found online. Past performance is no guarantee of future results.

L a n e A s s e t M a n age m e n t
Treasury Rates

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This new chart shows the percentage increase in 1, 5, and 10-year Treasury rates since the beginning of the year. Its interesting to note that the 1-year rates have actually declined during the period while the other rates have increased. Note that the Fed only controls the Fed funds rate which is the short term overnight rate provided to banks maintaining reserves at the Fed. Its purchases of mortgage-backed securities and longer term Treasuries (the other part of QE) also help to restrain rates of longer duration. So, while prevailing Treasury rates are influenced by the Fed actions, since nothing really happened in the Feds QE program in May to kick off the sharp increase that began at that time other than Bernankes comments, this chart is useful in that it shows what investor expectations are for the direction of prevailing interest rates. As Bernanke changed his tone in July to indicate that prevailing conditions will determine future Fed action and that nothing was fixed in stone, market expectations stabilized.

L a n e A s s e t M a n age m e n t
12-Month Performance

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The chart below shows the last 12-month performance of the indicated ETFs, the same ones that are on page 1. The performance speaks for itself, but a few observations may be useful:

Large cap domestic equities (SPY) recovered in July, outdistancing all other sectors, save Europe. The 25% gain for the last 12 months is a slight increase from the 23% 12-month gain we saw last month and suggests a slightly increasing momentum. European equities (EZU) exploded in July producinga 12-month gain of 32%, up from 25% in the prior months chart. Although I ex pected SPY to overtake EZU in July, that didnt happen, possibly on account of the recovering nature of Europes recession. While gold (GLD) had a modest recovery in July, its weak trend looks intact. As the direction of golds price is largely dri ven by expectations of dollar weakness, as the U.S. economy is slowly improving, I dont see much opportunity for a significant rise in the price of gold i n the short run. On a longer term basis, gold may, in fact, rise, but its not at all clear that the rise will outpace a well diversified equity portfolio. Oil (DBO) remained stable in July with a slight improvement in price. As price seems to be a function of a combination of global GDP, the value of the dollar, and geopolitical events that may affect oil availability, the rough stability of price over the last 12 months suggest these factors are largely benign or offsetting. Emerging market equities (EEM) recovered a bit in July and are essentially flat for the last 3 years while SPY has gained over 60%. Some see this as a buying opportunity. My view is that Id like to see a little more positive momentum before making that call. Investment grade corporate bonds (LQD) only marginally improved in July and are essentially flat for the last 12 months. This is in contrast to the

roughly 10% per annum gain of the preceding 3 years and, in my view, a likely indicator of prospective returns.

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L an e A ss et M an ag em ent
Disclosures Edward Lane is a CERTIFIED FINANCIAL PLANNER. Lane Asset Management is a Registered Investment Advisor with the States of NY, CT and NJ. Advisory services are only offered to clients or prospective clients where Lane Asset Management and its representatives are properly licensed or exempted. No advice may be rendered by Lane Asset Management unless a client service agreement is in place. Investing involves risk including loss of principal. Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity. Small-cap stocks may be subject to higher degree of risk than more established companies securities. The illiquidity of the small -cap market may adversely affect the value of these investments. Investors should consider the investment objectives, risks, and charges and expenses of mutual funds and exchange-traded funds carefully for a full background on the possibility that a more suitable securities transaction may exist. The prospectus contains this and other information. A prospectus for all funds is available from Lane Asset Management or your financial advisor and should be read carefully before investing. Note that indexes cannot be invested in directly and their performance may or may not correspond to securities intended to represent these sectors. Investors should carefully review their financial situation, making sure their cash flow needs for the next 3-5 years are secure with a margin for error. Beyond that, the degree of risk taken in a portfolio should be commensurate with ones overall risk tolerance and financial objectives. The charts and comments are only the authors view of market activity and arent recommendations to buy or sell any security. Market sectors

and related exchanged-traded and closed-end funds are selected based on his opinion as to their usefulness in providing the viewer a comprehensive summary of market conditions for the featured period. Chart annotations arent predictive of any future market action rather they only demonstrate the authors opinion as to a range of possibilities going forward. All material presented herein is believed to be reliable but its accuracy cannot be guaranteed. The information contained herein (including historical prices or values) has been obtained from sources that Lane Asset Management (LAM) considers to be reliable; however, LAM makes no representation as to, or accepts any responsibility or liability for, the accuracy or completeness of the information contained herein or any decision made or action taken by you or any third party in reliance upon the data. Some results are derived using historical estimations from available data. Investment recommendations may change without notice and readers are urged to check with tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is intended for illustrative purposes only. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. Periodically, I will prepare a Commentary focusing on a specific investment issue. Please let me know if there is one of interest to you. As always, I appreciate your feedback and look forward to addressing any questions you may have. You can find me at : www.LaneAssetManagement.com Edward.Lane@LaneAssetManagement.com Edward Lane, CFP Lane Asset Management Stone Ridge, NY Reprints and quotations are encouraged with attribution.