October 6, 2013

Economic and Market Recap

Last month, we talked about the clouds on the horizon. This month, we can talk about the bullets that were dodged during September: no attack on Syria, Larry Summers pulling out of contention as Fed chairman, and the Fed postponing the winddown on QE. Interestingly, even the government shutdown seemed to have even less effect than might have been imagined. While short-term exogenous risks remain, e.g., an extended government shutdown and/or unresolved impasse on the debt limit, my larger concern now is whether the market has gotten ahead of itself in the event of slower than expected corporate earnings growth when third quarter results start appearing. With above average market valuations, weak earnings could turn out to be the next bullet.

L a n e A s s e t M a n age m e n t
Stock Market Commentary
modest to moderate economic growth, the U.S. market continued to gain while the European and emerging markets couldnt contain themselves as the good economic news continued to pore forth. Then came the triple whammy of a possible avoidance of a Syrian strike by the U.S., Larry Summers withdrawal from consideration as Fed chief, and the Fed deferment of QE tapering (it doesnt get much better than this). Then enthusiasm waned (or profit-taking set in), taking some steam off the markets for the rest of the month. This relief was then reinforced by weak U.S. retail sales figures and growing concern about a U.S. government shutdown (later realized). Interestingly, the market seems to be taking the shutdown in stride, at least, so far. Well see what happens as the debt ceiling date comes closer. Investment Outlook As valuations remain stretched and the market currently looks overbought, despite all the good news in September, I think there is still reason to be cautious heading into the balance of the year. If a 5-15% correction concerns you, I would take some equity exposure off the table. That said, as of this writing, there are still areas of good relative performance, including:

Everything seemed to come together in September. The month kicked off with strong fundamental news in the U.S. with manufacturing sector activity keeping pace with its highest level since June 2011 and in Europe as similar manufacturing indices hit a 26-month high. This was followed by reported growth in Chinese factory activity, U.K. factory indices hitting a 30-month high, and U.S. nonmanufacturing indices hitting their highest level since 2005. Then, despite, or perhaps as a result of, a weaker-than-expected jobs report, and the Feds Beige Book reporting

Healthcare, especially biotech Consumer discretionary Industrials Large cap value International developed markets, especially Europe Emerging markets (longer term) Short term high yield bonds and floating rate loan funds.
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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
Last month, I evaluated the risk as being greater to the downside on account of price having broken below the 50-day moving average (50DMA) while there was no increase in volume to support a reversal and also weakness in the MACD. Going by what happened next, perhaps on account of the bullets we dodged (see first page side bar), the first couple of weeks of September defied my expectations. Then, Washington came to my rescue by entering into what looks like a long government shutdown. With that, the market slumped again.

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Although, as of this writing, price is still above the 50DMA (just) and the trend line is positive, we still dont have the s pike in volume I am looking for to support a reversal and the MACD momentum indicator is weakening again. Therefore, Im going to stick to my guns f or now and say that the risk remains to the downside. Of course, a settlement on the Federal budget could change things in an instant.

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

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 11.5%. Movement within this channel and in this perspective remains positive but weakening. This is seen in the facts that a) the 50DMA up slope is decreasing, b) new highs since May are barely occurring, c) the MACD is achieving lower highs since May, and d) were not getting the normal volume action that has been supportive of a rebound in price.

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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 near the top of the channel for the 6th time in over 4 years, (and 3 times since April) with 2 out of 6 of the prior times resulting in a significant 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 even more worrisome when combined with the knowledge of the stretch in the market valuation (S&P 500 PE ratios). With consideration to this chart alone, there is good reason to keep exposure to equities below ones long term strategic allocation. Since SPY has rea ched back to the top of the channel without an intervening correction, it may be a particularly good time to take some equity exposure off the table.

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 continuing to show characteristic volatility with a rapid recovery from the breakdown that occurred in June and again in August. With the recovery that occurred in early September (motivated, Im sure, not only by the bullets dodged in the U.S., but also by emerging strength in Europe as it comes out of recession), price broke through resistance around

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$48.10 and now appears to be retesting that barrier. If it remains above, $48.10 becomes a new line of support. With the strengthening fundamentals in Europe, as long as the U.S. doesnt cause financial disruption by not extending the debt ceiling, and as long as we avoid military conflict in the Middle East, I am encouraged by the direction of the technical indicators in this chart. As Ive mentioned in the past, international performance can be very localized. Currently, the Euro Zone and developed markets generally have been outperforming the broader index, while emerging markets have been underperforming (before September). Overall, I have become more optimistic on international equities, particularly in the developed markets, though preferring to add exposure slowly in light of recent volatility (see next page).

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 (IGC) bond index (LQD) on the left, and to the Vanguard Allworld (ex U.S.) index fund (VEU) on the right. While the relative weakness in August for equities vs. IGC bonds returned in September, the trend of the relationship still favors equities, though with decreasing momentum. As the relationship is likely to be volatile over the coming months as interest rates fluctuate, I expect the underlying trend favoring equities to continue. On the right, international equities extended their relative outperformance to domestic equities in September and the pattern seems to be now firmly in place. As I indicated last month, the changing slope of the moving average is an encouraging sign to increase the relative equity weight toward international. My only concern from the current chart is the deepness of the MACD momentum indicator which could be suggestive of an overbought situation for international. While I am comfortable increasing international exposure at this time, I would do so on a gradual basis.

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
Income Investing
While income investing has gotten a bad name in the last few months as the reaction to the Feds contemplation of tapering its bond purchase program in May resulted in a spike in interest rates, that does not mean the sector should be abandoned altogether. In prior months, I spoke of the outperformance of preferred stocks to investment grade corporate bonds. This month as I did last month, I draw

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attention to short term high yield corporate bonds represented here by PIMCOs exchange -traded fund HYS. On the left below is a 2-year chart of total return for HYS. While the 2-year return is an impressive 10% annualized, note that for the latest 12 months the total return has declined to a still respectable 7.5%. The chart on the right below contains the relative performance for HYS vs. investment grade corporate bonds (LQD) showing their similarity of performance during a period when LQD was rising, but significant outperformance since the first of the year as LQD has faltered. While the current yield on short term high yield bonds is less than the longer-duration Liquid High Yield Index (currently about 4.6% vs. 6.4%), their short term nature results in the fund being less susceptible to interest rate risk while at the same time benefiting from a rising rate environment as bond turnover is reinvested at new higher rates.

HYS is the PIMCO 0-5 Year High Yield Corporate Bond Index which seeks to correspond to The BofA Merrill Lynch 0-5 Year US High Yield Constrained IndexSM*. 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 chart shows the percentage increase in 1, 5, and 10-year Treasury rates since the beginning of the year. In percentage terms, rates skyrocketed in August and the first week in September with the 1 and 5-year rates increasing over 20% during the period while the 10-year increased nearly 10%. Since then, as a result of the non-tapering event in September, the 5-year rate lost about a third of the increase it achieved since May while the 10-year rate, which hadnt spiked quite so far, also lost ground (and is now about 2.65%, down from nearly 3% in early September). The drop in rates has, of course, benefited income-oriented investments such as investment grade corporate bonds. However, on fundamental grounds, I suspect rates will not return to the levels they were prior to May and, even if they do, the outlook is for higher rates longer term the only question being when. Accordingly, investments in income-oriented securities should keep durations short, under, say, 5 years.

L a n e A s s e t M a n age m e n t
12-Month Performance
The chart below shows the last 12-month performance of the indicated ETFs, the same ones that are on page 1.

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Large cap domestic equities (SPY) recovered ground in September, but the 12-month picture remains similar to last month at a healthy 17.5%. I expect the 12-month pace to pick up next month or, at least have a cushion against deterioration, as year-ago negative returns in October 2012 are eliminated from the chart. The Euro Zone (EZU) (and developed international markets, generally) had a strong showing last month on strong fundamental reports and has now overtaken domestic equities on a rolling 12-month basis. Note that the broader international index (VEU) remains below SPY for the 12 months, highlighting the outperformance of Europe. Gold (GLD) fell back in September and is close to establishing a new 12-month low. This came as a surprise to some who expected gold to rise in the wake of the Fed postponing its tapering decision. Oil (DBO) had a flat month as the conditions in the Middle East eased a bit but, by dropping a negative month from the 12-month view, posted an improved performance for the current 12-month period. Emerging market equities (EEM) had a strong month in September owing to rising global purchasing managers indices (PMIs) as well as coming off a very weak year. In addition, deferral of Fed tapering, keeping interest rates low, is seen as a major benefit to exporting nations in emerging markets. According to Forbes, the P/E ratio for the MSCI EM Index is over 23% below its long term average. Investment grade corporate bonds (LQD) dropped a strong month from the earlier part of the chart , depressing its current 12-month performance

even though September was a relatively good month as the Fed put off its tapering decision.

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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 Kingston, NY Reprints and quotations are encouraged with attribution.