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

July 15, 2018

Stock Market Commentary

Market Summary
Since my last Commentary in late May, the S&P 500 has wobbled
about, finally gaining a very healthy 3.5% (5.7% YTD) while interna-
tional equities sank and investment grade (IG) corporate bonds gained
nearly 1.9% (both International equities and IG bonds remain under-
water for the year so far). At the risk of over-simplification, I see three
competing forces driving investment markets today:
 International trade negotiations
 Earnings expectations, and
 Stretched market valuations.
A few economic U.S. events mostly positive and worth noting are :
 The unemployment rate is hovering around 4%, near a multi-decade
low point; the labor force participation rate (LFPR) for those 25-64
years old is edging upwards though remains about 2.5% below the
level achieved in 2000
 The final estimate of Q1 real GDP annualized rate of change
came in at a disappointing 1.35% (2% on a per capita basis)
 Inflation-adjusted average hourly earnings remain basically stag-
nant
 Small business confidence remains near a record high
 The latest year-over-year increase in retail sales was 5.9%, up
from the prior period
 The Conference Board Consumer Confidence Index remains
near a level not seen since 2001.
See selected charts on the next page.

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 to-
tal 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 opportu-
nity. 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
 L a n e A s s e t M a n age m e n t Page 3
Market Valuation

Market Valuation
The primary concern for investors, outside of “Black Swan” events
such as war or other catastrophe, is market overvaluation leading to a
major correction as it has in prior years. Despite the recent volatility,
there’s no doubt that the U.S. market remains overvalued by historical
standards as shown in top chart on the right. Since the last report in
May, the over valuation has increased slightly from 96% above average
to 100% above.
On the bottom chart, the 10-year subsequent nominal total return of
the S&P 500 is shown in relation to the average market valuation of
the top chart. For example, with the market valuation that existed 10
years ago, the subsequent 10 year return was 9.74%. The point here is
that since 10 years ago, the market valuation has basically exploded
suggesting that subsequent 10-year returns will be even lower than the
9.7%. Note that these indicators ARE NOT USEFUL as short-term
signals of market direction.
In a confirming note, Research Affiliates’ (“RA”) current view is that
their 10-year nominal return forecast for U.S. large cap equities
slipped to 2.5% from the 2.7% I last reported. Using their inflation as-
sumption of 1.2%, the inflation–adjusted 10-year forecast for large cap
U.S. equities of 0.3%. Small cap U.S. equities have a slightly higher
nominal forecast of 2.8%. RA sees the 10-year expected nominal re-
turn for global (including U.S.) equities of 4.9% driven by an expected
10-year return for EAFE markets of 7% and emerging markets of 9%.
The expected return for non-U.S. equities is a reversal in relation to
the return for U.S. equities in the last 10 years. In other words, RA ex-
pects a catch-up. While I see their point, I am not yet convinced.
 L a n e A s s e t M a n age m e n t Page 4
Recession Risk

I believe the recession risk is low for at

least the next two quarters. One reason
for that is the position of the yield curve
as shown here. The yield curve, the differ-
ence between the constant maturity 10-
year and the 2-year U.S.Treasury bond
yield rates, while continuing to move in a
threatening direction, is some distance
away from the inverted curve position
that has immediately preceded the last 5
recessions.

Here’s another chart suggesting the risk

of recession remains low. Here, the red
dots indicate the position of the PMI
Composite Index one quarter prior to
the onset of a recession. Typically, that
dot is at or below a reading of 50 on the
PMI Index. Since we are a good distance
above 50 at the moment, we have an-
other reason why I believe the risk of an
imminent recession is low.
 L a n e A s s e t M a n age m e n t Page 5
Market Valuation

Finally, here is one chart I use as an alert to the potential of a major market correction. I call this my Portfolio Protection Strategy and it works
like this. First, I chart the monthly price movement of the S&P 500 index on a logarithmic scale (this shows the price increases in percentage
terms). Then, I overlay a 7-month (“fast”) moving average and a 15-month (“slow”) moving average. This overlay indicates when price is rising
or falling. A similar device is at the bottom of the chart to show the momentum of the price movement.
While past performance is no guarantee of future results, the red arrows show when the fast moving average crosses over the slow average.
Each time this happened and a similar crossover occurred on the momentum indicator, a major market corrections occurred, especially the last
two times.
I see this chart as a way to avoid a large market correction, while smaller and even moderate corrections of 10% or more can occur without the
crossover triggers happening as it did at the end of 2015/early 2016. When that happens, it would be prudent to take at least some risk off the
table as we wouldn’t know at that point in time whether a larger correction is about to occur. While we experienced a 10% correction in Janu-
ary, a rapid recovery followed.
 L a n e A s s e t M a n age m e n t Page 6
Market Outlook for 2018

Market Outlook
Here is a summary of what I said back in January about my expectations for 2018 with updates in red:
 U.S. equities will perform well on the heels of strong corporate earnings — the S&P 500 is up about 5.7% YTD as of this writing as it
deals with cross winds of stronger profit performance offset by international trade concerns and rising interest rates
 Emerging market equities, especially Asia, will outperform the U.S. — so far, that view is at best “premature” as both EM and Asia are
lagging the U.S. with EM down over 6% YTD
 Equities will outperform bonds — by over 9% YTD and increasing
 Investment grade bonds will struggle to match their 2017 (generous) return of 7%, and may even go negative — down about 3% YTD
 If a market correction occurs, it will be relatively short-lived and probably not exceed 10%, plus or minus — that’s exactly what happened
in January/February and again in late March
 If the Fed tightens too aggressively, a significant hiccup is likely to occur — we’re safe so far
 Analysts will be carefully watching recession indicators — I am, too
 November midterm elections will not change the picture much, regardless of how they turn out — too early to tell
 All bets are off if war breaks out somewhere — so far, so good.
For a deeper dive, here are some additional thoughts (heavily aided by the many publicly available analyst resources):
For the U.S.
 U.S. GDP growth in 2018 will remain sub-3% (within a small range of error) — correct for Q1, but Q2 is looking much better
 The unemployment rate will continue to drift downwards — so far, right on
 “Full” employment will drive wage growth but real (inflation adjusted) wage growth will be remain low — so far, right on
For the U.S. (cont.)
 EPS growth will be in the neighborhood of 10% — Q1 was over 20% and Q2 looks about the same
 Rising interest rates may dampen equity growth but not so much as to offset its outperformance relative to bonds — true enough
 L a n e A s s e t M a n age m e n t Page 7
Market Outlook for 2018

 A weakened dollar and global growth will drive U.S. exports so long as disruptive trade policies are not adopted — the dollar has been
strengthening which may be contributing to recent weakness in exports and strength in imports, worsening the U.S. trade balance
 Recession risk will grow but will be avoided during 2018 and raise the stakes for 2019 and 2020 with implications for the next presidential
election — so far, so good, though this can’t last forever
 Corporate indebtedness, nearing 100% of GDP and well above its previous record of 91%, will come into sharp focus as interest rates rise
(earnings generated by tax relief will need to be used to pay down this debt before it becomes a significant issue) — this problem is not
getting any better
 Record levels of margin debt could exacerbate a stock market downturn — we’re getting into nosebleed territory

 The nearly 22% gain for the S&P 500 in 2017 and the 15.7% annualized gain over the last 5 years is very unlikely to be repeated over the
next 5-ish years with some analysts seeing single digit or negative returns once the business cycle completes sometime in the next few
years — That’s certainly the way it looks right now; see page 3
 L a n e A s s e t M a n age m e n t Page 8
Market Outlook for 2018

For International Markets

Emerging Markets
When it comes to international equity markets, it looks like emerging markets, especially Asia, are poised for the best outcome in 2018,
perhaps even better than the S&P 500. While Goldman Sachs sees the greatest absolute growth in India and China, Brazil is seen as having
the greatest relative growth — We’re still waiting for this outcome
Eurozone
 Like emerging market equities, Eurozone equities seemed poised to outperform the S&P 500 again in 2018 — as we sit today, this has
not happened; France and Italy have performed the best relative to the broad international index
Elsewhere
 Canada, Mexico, and Australia have the best performance relative to the broad international index YTD, but it’s a very volatile situation
Fixed Income
 Fixed income securities will be under pressure in 2018 as interest rates and expected inflation are rising in the U.S. and elsewhere —
correct, so far
 The best options for fixed income will be convertible bonds, shorter duration straight bonds, and floating rate securities — again, correct,
so far.
A final word
While I and most analysts I read do not anticipate a recession in 2018 (the risks increase for 2019 and 2020 as the business cycle peaks) and
stretched valuations make the equity market vulnerable, especially in the U.S. There are three ways for investors to approach this:
 Reduce equity exposure by dollar-averaging down and wait for the correction,
 Ignore the potential and commit to riding it through with the belief that it will be relatively short-lived, or
 Pay careful attention to your most reliable indicators and invest/divest tactically.
Each one of these options remains valid and the choice depends on one’s risk tolerance, belief in the future, and confidence in the investment
tools and advice at hand.
** *** **
 L a n e A s s e t M a n age m e n t Page 9
S&P 500 Total Return

Despite disturbing growing threats about a trade war with China, Europe, Canada and Mexico (among oth-
ers), the S&P 500 continues to advance in its long term advancing channel, likely as a result of the very fa-
vorable outlook (+20%) for Q2 corporate earnings. Likewise, momentum has also been in a positive trend
for the last several months.
So why do I have the caution light? When it comes to the S&P 500, almost 70% of the YTD gain can be
traced to the 5 FAAMG stocks (Facebook, Apple, Amazon, Microsoft, and Google/Alphabet); over 80% if you include Netflix. Although tech
stocks are expected to have even greater Q2 earnings growth than the index as a whole, this concentration is always a source of concern as it
suggests the fragility of continuing performance and the risks associated with concentration high priced growth stocks. Moreover, a consider-
able portion of earnings growth is coming from a reduction in the corporate tax rate, a year-over-year phenomenon that will fade in future peri-
ods. For now, the technical outlook is positive but it helps to have some idea how the future could unfold.

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 10
All-world (ex U.S.)

The picture for international equities (ex U.S.) represented here by the Vanguard ETF VEU, looks consid-
erably worse than for the S&P 500. From a technical standpoint, there’s nothing to like about the declin-
ing trend and momentum. The last several months were particularly bad periods for emerging markets
(EM), especially in Asia and Brazil. Chinese stocks make up a large portion of EEM, the emerging markets
fund followed by many and the second most actively traded fund after SPY.
And, it’s because of the heavy weighting of Asian equities in EEM and the 50% weighting of EM and Pacific region equities in VEU, that I have the
yellow caution light lit for international equities. In contrast with my concern about U.S. equities mentioned on the prior page, for international
equities, especially EM and Pacific region, I believe a recovery to their former relative strength will occur at some point, depending in no small
degree on the state of international trade relations. This bears watching as an opportunity for portfolio reallocation in their favor. The problem
is, as we look today, there’s no visible (technical) indication that the right time is near at hand. EM/Pacific equity entry at this point should an-
ticipate possible further deterioration and be thought of as a long term strategy.

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 Page 11
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 I’ve
found for establishing and revising asset allocation comes from observing the relative performance of major asset sectors (and
within sectors, as well). Unless one is out of the market altogether, the allocation decision can help investors reduce exposure to
underperforming assets and increase exposure to those that are over performing. The chart below shows the relative performance
of the S&P 500 (SPY) to the Vanguard All-world (ex U.S.) index fund (VEU).
Since my last Commentary, the S&P 500 has exploded relative to international equities, largely on account of the deterioration on the interna-
tional side. While I believe U.S. equities will outperform the broad international index over time, I doubt the recent experience is sustainable
without a correction in the relative performance — or, at least, the emergence of a new level of relative stability. For that to happen, I believe
we’ll need to see reduced threats of a trade war

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 12
Income Investing

Investment grade (IG) corporate bonds, represented below by the exchange-traded fund LQD, have per-
formed as expected, namely, deteriorated in a world of rising interest rates and inflation expectations. A
bit of recovery in early July consistent with the improving momentum since late May I believe is a tempo-
rary phenomenon despite the positive turn in trend. My suspicion is that the improving trend for bonds
may be driven more by demand as investors shift away from equities (you might see this in the weaken-
ing volume for SPY on page 9) than by a reflection of what investors are anticipating in the way of interest rates.
That said, here, again, I have a cautious outlook as the future of interest rates may be more in doubt than I would have expected as fixed income
(bond) demand will keep a lid on rates. At the moment, convertible bonds, floating-rate bonds and dividend stocks seem to me to represent the
best value for income-oriented investors.

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 13

Asset Allocation and Relative Performance

While the trend of relative strength in the S&P 500 to investment grade corporate bonds remains positive (though volatile), the
momentum has taken a negative turn suggesting weakness in the positive trend. Such divergence is rare and does not last very
long implying either that momentum will turn in favor of equities or the trend will turn in favor of bonds in the not-too-distant
future. While the trend favors equities, especially with the breakout above the latest resistance level, we need to be cautious on
account of the continuing stretched valuations for equities as well as uncertainty regarding international trade conflicts. From
an asset allocation perspective, a tilt toward equities appears to continue to be appropriate today consistent with the investor’s risk tolerance
bearing in mind the increasing risk for both equities and fixed income.

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.
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 is 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 illiq-
uidity of the small-cap market may adversely affect the value of these invest-
ments.
Investors should consider the investment objectives, risks, and charges and ex-
penses of mutual funds and exchange-traded funds carefully for a full back-
ground 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. Be-
yond that, the degree of risk taken in a portfolio should be commensurate
with one’s overall risk tolerance and financial objectives.
The charts and comments are only the author’s view of market activity and
aren’t recommendations to buy or sell any security. Market sectors and re-
lated exchanged-traded and closed-end funds are selected based on his opin-
ion as to their usefulness in providing the viewer a comprehensive summary
of market conditions for the featured period. Chart annotations aren’t predictive
of any future market action rather they only demonstrate the author’s 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 de-
rived using historical estimations from available data. Investment recommenda-
tions 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 ob-
jectives 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 with-
out notice. This information is intended for illustrative purposes only. PAST PER-
FORMANCE 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, ASA, CFP®
Lane Asset Management
Stockbridge, MA