March 8, 2013

Economic and Market Recap John Maynard Keynes made this famous quote and some people believe thats the situation were in today. After all, unemployment is nearly 8% in the U.S.; nearly 12% in the Euro Zone. U.S. annualized GDP is running around 1.6% while the EZ is in recession. So, how is it that the market keeps plowing ahead? First, the stock market (equities) reflects the real and expected profitability of corporations while GDP reflects spending. Those are two different things. Corporations can increase profitability while the economy struggles. Secondly, central banks here and abroad are depressing interest rates and flooding markets with currency. How long these factors can last in a struggling economy is the question.

L a n e A s s e t M a n age m e n t
Stock Market Commentary
as of mid-February, 70% of reporting companies beat expectations. Once the sequester became downplayed, U.S. stocks have taken off with todays better-than-expected employment report adding fuel to the fire. Meanwhile, both Europe and Emerging Markets were weak through the month owing to Europes recession and populist results in the Italian election and, for EM, weakness in Latin America. Since the beginning of March, both have regained ground in tandem with the U.S. Both oil and gold have been weak throughout as the dollar has strengthened. Investment Outlook
My long term investment outlook is positive; no change from last month. Earnings continue to beat expectations, the economy continues to slowly improve, and government policy makers have proven that they are not quite ready to take away the punchbowl. As for the sequester, while it may create some drag on the economy, market participants seem to believe the effect will be negligible. My biggest concern is that the market is overdue for a correction. However, even if (or when) a correction occurs, I dont expect it to be especially deep or long certainly not of the type experienced in 2001 or 2008. But that doesnt mean theres nothing to be done in preparation. First, investors should anticipate that a correction is likely to occur, perhaps 10-15% or more, before the end of the year. No one really knows if that will occur, but there is strong historical precedent as well as technical indication. If that is unnerving, then risk should be taken off the table. Rather than guess when to make adjustment, however, my preference is to pay attention to relative performance charts such as the ones shown on page 4. While action taken based on these charts cannot be timed perfectly, the trends shown tend to last long enough to justify reliance on them.

The chart below covers all of February and through March 8th to capture the effect of the passing sequester and todays employment report for February. Domestic equities held up through February despite the looming sequester, a recession in Europe, considerable weakness in Latin America, and a mixed bag of economic reports, including the bullish Goldman Sachs downgrading U.S. stocks for the next 3 months from overweight to neutral. Again, I think the story is corporate earnings where,

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 recommended caution with regard to domestic equities. As we entered February, while trend remained strong, momentum (bottom indicators) was slowing and reaching levels consistent with a correction as was true last March and September. From a support/resistance standpoint, I saw we were in uncharted territory as the index sought a new line of resistance. My sense was to continue to advise caution about adding new positions. Even though economic indicators were generally positive, we were even more

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extended on the bull run and the jury was still out on the handling of the sequester in Washington. I said that it was not impossible that the run would continue longer, but I wouldnt rush out to buy more domestic equities. Well, like many who forecast the future, I dont know if I was wrong, but I was surely premature as U.S. stocks have set new all-time highs and the upward trend remains intact as U.S. companies and the economy, in general, continue to recover. That said, on a technical basis, I remain wary of adding exposure to U.S. stocks at this time. Although the trend remains positive, the momentum indicators (bottom of the chart) are at a place consistent with some sort of price correction.

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.)
Last month, I suggested a holding pattern on international equities on account of even greater weakness in the momentum indicators than was true for domestic stocks. Again, as with domestic equities, this turned out to be a bit, shall we say, premature. As we sit today, we can observe that VEU has bounced off support of the moving average and seems to be on the verge of a potential reversal of momentum to the good, as well. That said, Im still not ready to jump in with both feet as the price of VEU approaches resistance just below $49 and the momentum indi-

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cators have not made a convincing move just yet. Remember that VEU covers the entire world outside of the U.S. As may be found with careful analysis of individual sectors in the U.S., select countries and regions may provide more opportunity than the broad index fund.

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. As shown on the left, domestic equities are strongly outperforming investment grade corporate bonds. So strongly, in fact, that a correction of some nature should not come as a surprise as the momentum indictors are signaling an overbought situation. On the right, we see that domestic equities bounced back relative to international in January. Based on the change in direction for the momentum indicators, I expect domestic equities to extend their relative strength. This is not to say I would avoid international equities as they provide proper diversification only that it may be worthwhile to overweight domestic equities at this time.

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

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 for 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 the

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turnover of bonds to those with higher yields to offset, at least somewhat, the impact of rising rates on the portfolio. Of course, another factor is at work, and that is investor demand. Whatever the reasons, its clear from the chart on the left below that the technical direction of LQD has turned south. And with that, I would advise caution as I believe there are better places to be in the income space. One of those better spaces is preferred stocks. As shown in the chart on the right, following a period of about 7 months of roughly comparable performance between LQD and PFF, the preferred stock index now seems to be taking control. But preferred stocks are not the only incomeoriented alternative to investment grade corporate bonds. Investors should look also into emerging market bonds, multi-sector bonds, floating rate corporate loans, REITs and other income strategies that offer a good counterweight to equities and are not as affected by rising U.S. interest rates.

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
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) have had a very strong 12 months with a total return of over 15%, now the best performing sector of the observed group. February was a difficult month for European equities (EZU) though they appear to be bouncing back toward the end of the month. With known headwinds, Europe has done remarkably well over the last 12 months. Gold (GLD) slipped in October, seemed like it might be bouncing back, but has languished for the last ten weeks. While I realize some others feel differently, I believe gold is better suited for trading than for long term investment or hedging purposes. Following a two month recovery, Oil (DBO) has once again fallen behind, perhaps due to economic slowdown in Europe and the U.S. Emerging Markets (EEM) have languished over the last couple of months with some of the strongest headwinds coming from Latin America. Investment grade corporate bonds (LQD) have flat-lined and are actually turning negative in total return reflecting the strong support that is going into equities.

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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.