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November 19, 2016

L a n e A s s e t M a n age m e n t
Stock Market Commentary

Key Market Drivers


Anticipation of the election and its aftermath have been the big story
in the markets over the last several months since my last Commentary, but theres also been a generally promising economic backdrop.
Lets talk about the economics first.
With almost all of the S&P 500 reporting, average Q3 earnings and
sales increased 3.8% and 2.6%, respectively, a marked improvement
over the 4-quarter average of 4.6% and -2.3%, and the 12-quarter average of 2.3% and 0.7%, resp. If the energy sector is excluded, Q3 looks
much better with earnings and sales up 7.2% and 4.2%, resp., way
ahead of the 4-quarter averages of about 1% each and even ahead of
the 12-quarter averages of 5.9% and 3.6%, resp.
In addition, for the U.S.:

Consumer confidence attained its highest reading since June and is


near a 10-year high,

Housing starts in October had their highest reading since August


2007

Year-over-year retail sales increased 4.3% in October, about equal to


the average over the last 23 years

In a surprise to some, real (inflation-adjusted) average hourly earnings have risen to level not seen since 1979. Note that supply-side
economics popularized during the Reagan administration wasnt as
friendly to workers as some people may have thought

Although the labor force participation rate has been falling since
late 2001, it is only 4% off its peak at that time

The Conference Board Leading Economic Index achieved a new


all-time high with the index more than doubling its growth rate in
the last 6 months over the prior 6 months.

The charts on the following pages use mostly exchange-traded funds (ETFs) rather than market indexes since indexes cannot be invested in directly nor do they typically reflect the total return that comes from reinvested dividends. 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

Page 2

Stock Market Commentary


Key Market Drivers (cont.)

has taken a toll.

As for the election, in the period leading up to November 8th, despite


generally positive economic news as just discussed, it appears that equities were behaving cautiously. Given the ebb and flow of the preelection news, its not clear whether this was in anticipation of a Clinton or Trump victory.
One thing is clear, though, following the initial overnight shock to the
market when it became obvious that Trump would prevail, equities
have recovered nicely with the S&P 500 attaining a new all-time high
(see page 7). On the other hand, equities in Europe and the emerging
markets have not fared so well (see page 8).
While its too early to make a longer term prediction, the immediate result of the election has been good for U.S. equities, especially
for mid and small cap stocks, and not so good for international equities, bonds and gold.

For bonds, the picture has been less than rosy (see page 10). Following
a post-Volker low of 1.37% for the benchmark 10-year Treasury note
reached just last July, the yield has since risen almost 80 basis points to
2.34% with half of the increase occurring in the last 30 days. The popular idea of rates remaining lower for longer appears to be under threat.
Likewise, for gold and, to a lesser extent, oil, the rise in the dollar since
May relative to a basket of currencies for other developed economies

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

Page 3

Trumponomics (IMHO)
Trumponomics and What We Might Expect Going Forward

the S&P 500 is closer to 27% according to Vanguard).

The election is now over and weve had a few days to think about its
expected impact on the economy and, therefore, the stock and bond
markets. I wont lie; this was not the outcome I was hoping for. That
said, in my comments that follow, Ive attempted to set those thoughts
aside.

In the current iteration, I dont expect the change in the personal


income tax rates will have much of an impact on the economy
which would be manifest in consumer spending. Under the Bush
and Obama tax cuts in the early days of the recession, middle income folks used most of the money to pay down debt or save while
the higher income folks mostly saved. As for the changes in business taxes, the reduction in the top rate may have some impact on
corporate hurdle rates, but I dont expect to see a surge in investment without a significant pick up in demand. Of course,Trump
and the Republican Congress will see it differently. We can only
wait and see.

In truth, no one can really say with confidence what the impact will be
since no one can really say (including himself, I believe) either what
President-elect Trump was actually intending with his pre-election proposals or how far Congress will go towards Trumponomics. That said,
for what its worth, Im going to give it a shot.
For those of you who dont finish reading this section, let me say at the
outset that things rarely turn out as good (or as bad) as they might
seem at the beginning. Trumps impact on the markets could turn out
to be as good as he predicted or much worse as others have predicted.
More likely, with a Republican Congress, the outcome will be somewhere in-between.
What follows are the areas addressed by Trumps key economic proposals and my assessment of how they might work.
Tax Policy
Trumps individual income tax proposals, in their latest iteration, result
in a significant reduction in taxes for the top 1% who, according to the
Tax Policy Center, would get about half of the value of the program,
exacerbating income and wealth inequality. While Trumps plan original called for a 15% rate to be applied to all business income (including
partnerships and unincorporated small businesses), his latest plan only
mentions corporations and the 15% rate has been replaced by 33% (vs.
the current top marginal rate of 39.6% - though the effective rate for

Here is a summary of the outcomes I expect to see from Trumps


tax proposal:

No material impact on consumer spending or corporate investment;

An increase in corporate profits that will translate into improved


stock market performance, all other things being equal;

Absent a significant reduction in government spending, a large increase in the deficit which has been estimated by Trump himself
to be about $2.6 trillion and by independent evaluation at 2-3
times that amount. This may be more than enough of an issue to
give Congress a pause in pushing through such an expensive program.

Infrastructure
Before the election,Trump proposed some $500 billion in infrastructure spending, about twice Clintons.

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

Page 4

Trumponomics (IMHO)
Im not sure what Trumps latest thinking is, but Wilbur Ross, whose
name has been floated for Commerce Secretary, wrote a paper in October that suggested that the money to pay for Trumps infrastructure
program would come from the private sector in the form of long term
loans of $1 trillion supported by a federal tax credit of 82%.
According to Ross, the governments cost of the tax credit would be
offset by revenue generated by the new investment (I guess that
means private investors would own a piece of refurbished schools,
roads and new R&D, although how that would be done is a mystery to
me). In any event, if the government (thats you and me) is going to
pay for 82% of the cost through a tax credit (which is a lot more expensive than a tax deduction), why not 100% and retain the value for
taxpayers (but I digress)? According to CNBC, private financing of
public projects has had mixed success and has never been done in
anything like the scope being contemplated today.

given the difficulty employers are having finding skilled workers, its
not clear to me how these jobs will be filled. Moreover, if paid for
through reductions in other government expenditures, the net impact on employment would be offset.
Though the Republican Congress will want to support Trump in any
way they can, I have my doubts that Congress will go along with the
a significant infrastructure expenditure that is not paid for in some
other way and for which theyve shown little interest in the past, especially in the context of the proposed tax relief program (when
asked last September if he would support Trumps plan, Paul Ryan
simply laughed out loud).
Government debt has been rising since 1980 and is now just shy of
$20 trillion and is now about 104% of GDP, a level not seen since just
after WW II. The prospects for a Republican-led Congress to push

So, absent dynamic scoring that aims to take into account estimated
growth in the economy and, therefore, offsetting tax revenue,Trumps
infrastructure program is likely to add $500 billion to a $1 trillion in
new government debt over, say, 10 years. The anticipation of this increased borrowing is already being felt by the markets as, just since
the election, the 10-year Treasury note yield has risen from about 1.8%
to nearly 2.34% as of this writing.
As for employment, theres no doubt that a large infrastructure commitment would put many people to work, perhaps 1million or more,
as well as raise wage levels. To me, this is the key to driving demand
upon which the success of Trumps entire domestic program hinges.
The question is, where will these people come from when unemployment is now below 5%? There is slack in the participation rate but,

that higher the proposed infrastructure and tax plans seems dim.
Im not a political pundit, but if I were, Id say this could turn out to
be the make-or-break domestic issue for the Trump presidency
not whether there will be an infrastructure program, but how it will
be implemented and its ultimate effect on employment and the
deficit.

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

Page 5

Trumponomics (IMHO)
Trade Policy
The 2015 trade deficit in goods and services was about $500 billion,
nearly $760 billion in goods alone. The total 2015 deficit occurred as a
result of $2.3 trillion of exports being lower than the $2.8 of imports.
Trump has promised to not approve the Trans-Pacific Partnership (as
did Clinton) and also revisiting existing trade agreements such as
those with Mexico, China, Japan and others. He has even proposed restricting imports of oil from Saudi Arabia. Trumps view is that exports have been the primary source of manufacturing decline in the
U.S. and there would be a net improvement in employment by way of
renegotiation of existing agreements.
There are a number of reasons to expect little impact from Trumps
hoped-for trade realignment, including:

With $2.3 trillion of exports, the expectation that the U.S. can
rewrite trade agreements that wont have an offsetting impact
on exports (and, therefore, related jobs) is difficult to imagine
as trading partners work to serve their own interests, not to
mention the push-back from U.S. exporters;

As the dollar strengthens, as it has since the election and is


likely to continue to do so as the Fed raises the federal funds
rate, the benefit goes to imports at the expense of exports;

According to a recent article in Fortune, automation, not imports, has been the primary cause of the loss in U.S. manufacturing jobs (in fact, worldwide). Boston Consulting Group estimates that the impact of automation will more than double by
2025. Interestingly, according to a report by Ball State University, despite the loss in manufacturing jobs, manufacturing output has actually grown in recent decades, and that as much as
88% of lost manufacturing jobs were as a result of automation

and factors other than foreign trade; and

Should Trump prevail with his trade proposals, prices in the


U.S. (and elsewhere in the world) will go up leading to an increase in inflation which could put pressure on the Fed to
raise interest rates, further slowing the economy.

The bottom line, if Trump is successful with his trade policies, is that
U.S. employment would have offsetting forces and may not benefit
at all, inflation would rise in the U.S. and around the world, pressure
would mount to devalue currencies against the dollar and walking
away from TPP would open the door for increased Chinese influence in Southeast Asia at the expense of the U.S. This latter point
may not bother some people, but the long term implications would
not be pretty.
Deregulation
According to the website The Hill, while campaigning,Trump
called for repealing 70% (!) of existing regulations. The Hill suggests
that upwards of $42 billion of savings to the economy could be
achieved quickly through deregulation under the Congressional Review Act that permits a rollback of recently published regulations.
And thats only a fraction of the regulations that could be on the
chopping block, including those under Dodd-Frank, Obamacare, and
applying to energy production.
But heres the rub, at least in my opinion. While deregulation will
clearly benefit industry, I dont believe this will translate into job
creation, any more than I expect corporate tax relief to boost employment. In fact, with the recent stock market performance in
mind, it could be argued that neither does the market as stock
prices are probably reacting to an expectation of increasing profits
that wont be spent.

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

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Trumponomics (IMHO)
Immigration
One doesnt normally think of immigration policy in the context of
economic impact but, if Trump is successful in deporting the 2+ million
undocumented immigrants that have been proposed, this will have an
inflationary impact on both prices and wages.
According to the right-leaning American Action Forum, removing all
undocumented workers and barring their reentry would cost between
$400-600 billion and reduce real GDP by over $1 trillion.
Gross Domestic Product
Donald Trump has promised to deliver 4% GDP growth. With personal
consumption expenditures amounting to about 70% of GDP
Summary
As I said at the outset, when all is said and done, I doubt that the economic impact of Trumps presidency will be as good as his supporters
believe nor as bad as his detractors expect.
To achieve his goals, he will have to run over many in his own party and
rely on support from the Democrats. Even then, the potential for exploded national debt which will bring forth the next recession is high.
President-elect Trump is counting on growth in the economy to save
his bacon. If he is successful in pushing his programs through, I hope
hes right.
One thing Im sure of, however, now that Trump has won the election,
is that he will want to win the next one. In order to do that, hes going
to need to increase employment and hourly wages at a time when the
unemployment rate is already below 5% and weekly unemployment
claims are the lowest since 1973, all the while avoiding exacerbating
the national debt.
While the threat of gridlock is reduced with a Republican Congress, I

believe Trump will need a fair amount of support from Democrats


to achieve his objectives. For someone who prides himself on dealmaking, that may turn out to be the ultimate test.
One last thought. A divided government leading to compromise in
Washington was a hallmark of the time that many Trump supporters look back on with fondness. The days of compromise are long
gone, unfortunately.
We will now be trying a period with a single party controlling both
the White House and Congress. I believe most Americans hope
they will be successful whether or not they supported Trump as
there is much we need to accomplish. While I have my doubts his
methods will work, I wish him well.
** *** **

L a n e A s s e t M a n age m e n t
Market Valuation
The P/E 10 ratio (aka the Cyclically Adjusted
Price Earnings Ratio, or CAPE) is an alternative
calculation of the P/E ratio using a 10-year average
of inflation-adjusted earnings developed to overcome flaws in the traditional P/E ratio caused by
using current prices and recent quarterly earnings.
As shown in the top chart on the right, the P/E 10
is approaching 2 standard deviations from its mean
(average) value, a rare occurrence, or approximately where it was in 2007 just before the Great
Recession began. (Not shown is a very small improvement from the chart shown 2 months ago.)
On the bottom chart, in addition to showing the
P/E 10 well above its regression line, the chart also
shows the inflation-adjusted S&P Composite
(essentially the S&P 500) 85% above its long term
trend, another rare occurrence (a slight improvement from 90% shown 2 months ago).
Market valuation (which, in part, can be explained
by stock buybacks), should not be used to time the
market but rather as one more data point to take
into consideration as investors consider their risk
tolerance.
** *** **

Page 7

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

Page 8

S&P 500 Total Return


In my last report two months ago, I pointed out the weakening momentum and suggested we might be in
store for a 5% correction. As it turns out, the index came down about 4.6% since that time, hit support at
$208 and rebounded following the election to, at this time, a new all-time high. At this point, the trend is
slightly positive while momentum has the beginnings of a possible reversal to the good.
Whats not shown is the dramatic outperformance of mid and small cap stocks relative to the S&P 500
(large cap) following the election. While 10 days does not make a trend, I believe this reflects the view of investors that Trumps trade policies,
should they be implemented, will harm many large cap companies that depend on exports much more so than small cap companies. Moreover,
dollar strengthening along with a more protectionist trade policy, will be harmful to GDP growth as it favors imports over exports, all other
things being equal.
Since I suspect it will take a few months for the market to fully absorb the election, caution is advised. My view is that equities will continue to
do well relative to bonds and in absolute terms until theres evidence of weakening conditions in housing starts, consumer confidence, leading
economic indicators or other key economic indicators and as long as there are steps taken to improve corporate profitability such as those
mentioned in my analysis of Trumps tax and deregulation proposals in prior pages.

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

Page 9

All-world (ex U.S.)


What a difference two months can make! At the end of September, international equities, represented
here by Vanguards all-world (ex U.S.) exchange-traded fund VEU, had strong positive trend and the barest
notion of weakening momentum. The latest view is a sharp reversal that begin immediately afterward
and has not let up since.
Prior to the U.S. election, emerging markets were holding their own while it was the developed international markets, primarily in Europe, that led the weakening. Since the election, emerging markets have tumbled along with
the developed markets. As for emerging markets, this might be explained by the advancing strength of the dollar which makes dollardenominated debt of emerging countries that much more difficult to repay.
As for the developed markets, the cause of weakness is less clear, especially as the euro has weakened which ought to be seen as good for trade.
One cause must be growing protectionism around the world, brought into sharp relief with Trumps election (not to mention Brexit), seen as
problematic for exporters like Germany, China and England.
Technically speaking, the picture for international equities looks rather poor at the moment with declining trend and momentum. This may be
a good time to take some of international exposure off the table until the economic outlook improves. A key indication of where we go from
here will be how VEU responds to the current line of support at $43.50.

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. As of 11/4/16, VEU was allocated as follows:
approximately 19% Emerging Markets, 44% Europe, 30% Pacific and about 6% Canada. 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

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Asset Allocation and Relative Performance


Asset allocation is the mechanism investors use to enhance gains and reduce volatility over the long term. 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 chart below shows the relative performance of the S&P 500 (SPY) to the Vanguard All-world (ex U.S.)
index fund (VEU).
In this chart, the weakness of U.S. equities relative to international equities came to an abrupt end with the results of the U.S. election, although
hints of the developing weakness in international equities was beginning to appear in the month before that. As Ive said in the past, relative
strength for international equities has not had much longevity in recent years and that seems to be the case again. This turnabout is almost certainly due to concerns about international trade. It remains to be seen whether the immediate market reaction will be proven right.

SPY and VEU are exchange-traded funds designed to match the experience of the S&P 500, (with dividends) and the FTSE All-world (ex US) 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

Page 11

Income Investing
Investment grade corporate bonds, represented below by the exchange-traded fund LQD, began their
inevitable decline in September and completely collapsed with the prospect for rising interest rates
tied to a combination of Fed Chair Yellens recent indication that a fed funds rate increase was likely
coming in December and, more impactful,Trumps infrastructure proposal which could lead to substantial new government borrowing.
Honestly, while I do believe that bonds are past their prime as interest rates were sure to rise eventually, I believe well need to wait until after Trumps inauguration to see how Congress reacts to his infrastructure proposals which I think will be
difficult to swallow by the most conservative elements of Congress.

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

Page 12

Asset Allocation and Relative Performance


The stalemate in the relative performance of equities vs. investment grade corporate bonds that began around the beginning of
March ran out of steam with a vengeance following the U.S. election. As Ive pointed out in prior Commentaries, it was unusual
for the standoff between equities and bonds to last as long as it did there was surely some investment-related psychology behind it. Based on prior experience, such a strong reaction is likely to be met with an opposite reaction in coming days, or at
least a dead cat bounce for bonds. That said, I do believe the outlook for equities relative to bonds is back on the upswing for
now and would tilt my tactical allocation that way.

SPY and LQD are exchange-traded funds designed to match the experience of the S&P 500, (with dividends) 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

Page 13

Interest Rates
Shown on the left below are the 2-year and 10-year U.S.Treasury yields for the last two years. The 2-year yield might be
taken as a proxy for the markets opinion about what will ensue for the Fed funds rate. The 10-year yield is a reflection of
not only domestic attitudes about changes in the Fed funds rate and the demand for funds, but also the global interest
rate environment and developing strength in the U.S. dollar. As you can see, both yields have been increasing since bottoming in July with a spike upward following the election and anticipation of a significant increase in government borrowing
On the right, we see the current Treasury yield curve and its steepening since the beginning of September. Although not shown, the yield curve
is almost identical to what it was at the beginning of 2016 when anticipation was high for several fed fund rate increases during the year. When
they didnt materialize, the curve somewhat flattened. Now, with Chair Yellens recent remarks and the prospect for rising rates if Trumps infrastructure proposals should come to pass, we may be moving to an even steeper yield curve in coming months.

Page 14

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.

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 con-

Investing involves risk including loss of principal. Investing in interna-

tained herein or any decision made or action taken by you or any third party in reli-

tional and emerging markets may entail additional risks such as currency

ance upon the data. Some results are derived using historical estimations from available

fluctuation and political instability. Investing in small-cap stocks includes

data. Investment recommendations may change without notice and readers are urged

specific risks such as greater volatility and potentially less liquidity.

to check with tax advisors before making any investment decisions. Opinions ex-

Small-cap stocks may be subject to higher degree of risk than more es-

pressed in these reports may change without prior notice. This memorandum is based

tablished companies securities. The illiquidity of the small-cap market

on information available to the public. No representation is made that it is accurate or

may adversely affect the value of these investments.

complete. This memorandum is not an offer to buy or sell or a solicitation of an offer

Investors should consider the investment objectives, risks, and charges

to buy or sell the securities mentioned. The investments discussed or recommended in

and expenses of mutual funds and exchange-traded funds carefully for a

this report may be unsuitable for investors depending on their specific investment ob-

full background on the possibility that a more suitable securities trans-

jectives and financial position. The price or value of the investments to which this re-

action may exist. The prospectus contains this and other information. A

port relates, either directly or indirectly, may fall or rise against the interest of inves-

prospectus for all funds is available from Lane Asset Management or

tors. All prices and yields contained in this report are subject to change without notice.

your financial advisor and should be read carefully before investing.

This information is intended for illustrative purposes only. PAST PERFORMANCE

Note that indexes cannot be invested in directly and their performance

DOES NOT GUARANTEE FUTURE RESULTS.

may or may not correspond to securities intended to represent these

Periodically, I will prepare a Commentary focusing on a specific investment issue.

sectors.

Please let me know if there is one of interest to you. As always, I appreciate your feed-

Investors should carefully review their financial situation, making sure

back and look forward to addressing any questions you may have. You can find me at :

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.

www.LaneAssetManagement.com
Edward.Lane@LaneAssetManagement.com
Edward Lane, CFP

The charts and comments are only the authors view of market activity

Lane Asset Management

and arent recommendations to buy or sell any security. Market sectors

Lenox, MA
Reprints and quotations are encouraged with attribution.

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