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Lane Asset Management Stock Market Commentary September 2011

Lane Asset Management Stock Market Commentary September 2011

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Published by Edward C Lane

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Published by: Edward C Lane on Oct 15, 2011
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Market RecapAugust began with a downward revision to thesecond quarter GDP growth figure from 1.3%to 1.0% and global GDP figures also showed weakness. This news was taken as a signal thatthe world, at least the developed economies, were coming perilously close to dipping back into recession and many market analysts wereraising their probabilities of a double dip as if the first recession had ended. Although themarket recovered a bit during the rest of themonth, weak economic news continued leavingone to wonder whether the recovery, such as it was, was nothing more than a technical reac-tion to a sudden oversold condition. (Truth betold, we know there was further decline in thefirst two days of September following the Au-
 
gust jobs report.) Simply put, there was verylittle good news in August aside from an in-crease in consumer spending and durablegoods orders. Broader indicators, such as thePhilly Fed and the Empire Economic Indices,capital expenditures, the Case/Shiller homeprice index, consumer confidence, and the Julynon-farm payrolls, all were weak or declined tomulti-year lows.
The S&P initially dipped 13% but later re-covered over half the loss to end the monthdown nearly 5.7%. The emerging marketsindex fared worse dropping an initial 15%and recovering to a near 9% loss for themonth.
On the expectation of recession, oil fell
Stock Market Commentary
September 5, 2011
Lane Asset Management
If you’ve been following my
comments for the last several
months, you’ll know that I’ve
been concerned about whether the market correc-tion begun in April was just atechnical blip or the begin-nings of a more serious de-cline. With the sharp selloff atthe beginning of August, possi-bly triggered by a disappoint-ing GDP growth figure for thesecond quarter, I was justabout to claim a serious cor-rection was underway.Looking at the chart on theright, the S&P 500 and emerg-ing market indices stabilizedand actually recovered a bitlater in the month. Thiscaused me to hesitate with myprediction. With the S&Pstuck around the support/resistance level of 1200, weare at a critical point that willdetermine whether a further decline of 10% or more is inthe offing
 — 
or not. With political ineffectiveness
here and in Europe, I’m con-
cerned the odds favor further decline.Comments are welcome.
 — 
Ed Lane
nearly 18% but recovered to a 10% loss for themonth.
On the heels of a strong month in July, silver initially gave back some of its prior gains, butended the month up over 4%.
Gold barely took a breather from a strong July,then added another 12% to bring its 2011 gainthrough August to over 28%.
As investors dumped equities, bonds continuedtheir slow but steady upward grind by addinganother 2% in August. U.S. Treasury bondrates fell again to all time lows with 10 year rates dropping to very nearly 2% (a low notseen in 50 years) from 3.75% in February as in-vestors rushed to safety. (cont.)
 
Economic Outlook The economic outlook remains weak. Here are the fac-tors that concern me the most (in no special order):
Housing: The Case/Shiller index of property values fell4.5% from a year ago. On the bright side, the figuresfrom a year ago were inflated by special tax credits for new home buyers and the index has been relativelystable over the last 3 months. Regardless, the underly-ing problems remain with too much housing stock andtoo few willing and able buyers. Since Americansmeasure their wealth, in part, on the value of their homes, consumer confidence remains under pressure.And until the housing problem is resolved, our con-sumer led economy will struggle.
Employment: Forget the unemployment rate. Thelabor force participation rate and the employment topopulation ratio dropped to their lowest levels since
the early 1980’s. And long term unemployment,
 which has reached new heights, will exacerbate theemployment picture and economic well-being for mil-lions of Americans for years to come.
European debt: The sovereign and bank debt crisis inEurope threatens the entire financial world. Funda-mentally, according to those I read, there are onlythree ways out of the mess: currency devaluation and/or debt restructuring and/or severe public austerity.Since none of these approaches are politically palat-able at the moment, the crisis persists. But there is alimit to how long this can go on.
American debt: The U.S. also has its debt issues, bothpublic and private. Aside from currency devaluation which has its own set of issues, America is dealing withthe problem through public and private austerity anddeleveraging. While this is an effective way to deal with the debt, it exacerbates the employment problemand depresses economic growth. If a more creative
solution isn’t found, the so
-
called ―muddle through‖
economy is the best we can hope for for many years tocome.
Political deadlock: Focusing on the U.S., the funda-mental disagreement over the role and ability of gov-ernment to resolve the economic malaise (primarilyunemployment) has, so far at least, become a self-fulfilling prophecy. At the risk of over-simplification,one side feels the need for substantial governmentstimulus while the other side feels the need for re-duced government intervention and greater relianceon the private sector to do its thing. While both pointsof view have merit, neither can get off the ground onaccount of an unwillingness to compromise. Over thenext few weeks and months, Congress and the Admini-stration will have one last opportunity to deal with theproblem before the 2012 election. From what I cansee, there is little evidence to point to that suggeststhis opportunity will be seized upon.
Meanwhile, from an investor’s perspective, the news isn’t
all bad. Since equity values are fundamentally based onthe current and perceived future financial success of com-panies, as long as corporate profits remain strong, despitethese other factors, equity markets will thrive. As it hap-pens, S&P 500 earnings per share and adjusted after-taxcorporate profits as a percent of GDP are at pre-recession levels, probably owing to the globalization of business and the productivity that derives from a greater reliance on capital than labor (lowered employment).
Stock Market Commentary
Lane Asset Management
This correlates highly with equity values. The bigquestion is whether the economic headwinds inthe developed economies will overwhelm corpora-
tions’ ability to keep profits high.
 Investment Outlook Long term investors might conclude that the cur-rent market slump presents a buying opportunity,and they may be right. That said, I would pointout that many long term investors in 1998 wouldfind that their investments had not changed in
value over the last 13 years. Of course, that’s not
true for all equities, but finding long term winnersin a diversified portfolio is not easy. To wit, Invest-ment News reports that only 13% of mutual fundsbeat their benchmarks so far in 2011.Unless you can stand the volatility, I would be verycareful about adding equity exposure at this pointin time. My current suggestions are: basically thesame as last month:
High quality, dividend paying common or pre-ferred stocks
High grade corporate and government globalbond funds, especially U.S. TIPs (inflation-protected Treasuries)
Gold (see pages 3 and 4)
For taxable accounts, municipal bond funds.Given the extreme economic uncertainty andmarket volatility, I no longer recommend coveredcalls.
 
Page 3
Lane Asset Management
There has been a lot of discussion about gold as an alternative investment. While I’ve talked about the technical aspects of 
go
ld’s performance in
previous commentaries, I thought it would be useful to step back and provide some thoughts on gold as an investment and where it might gofrom here.First of all, it is important to remember that gold is not an ordinary investment. It does not have an earnings yield so its only value to an investor is determined by what you get back when you sell. The next important thing to remember is that gold has limited industrial use. That means the
main demand for it comes from the ―love trade‖ and investors. Although the love trade in Asia is growing rapidly and jewelry
represents the largest current sourceof demand for gold, in my opinion, the price of gold lately is more influenced by investor demand (which also happens to be the fastest growing source of demand).From my perspective, an investor in gold needs to take into account both the technical analysis of its price direction and the fundamental factors that drive the de-mand. Typically, supply and demand have the greatest impact on commodity prices. In the case of gold, as I understand it, the supply is rather tight and is growingat a relatively stable pace and short of demand. That means, absent a supply shock, that demand factors have the greatest impact on price.Based on my research, these factors are what drives the growing demand for gold:
The first is a real or expected decline in the value of the currency that is exchanged for gold or the basis for other investments. The graph on the next page illus-trates the comparative performance of the U.S. dollar and the price of gold. Although not shown, if you compared the change of the price of gold in dollars to the
change in value of a stronger currency, like the Swiss Franc, in dollars, you would get a much more muted picture of gold’s a
dvancing price. Real and expected de-clines in the value of the dollar have been a major source of demand for gold from individuals, institutional investors and central banks (who, according toBloomberg, are the largest holders of gold), especially if they hold large quantities of other assets denominated in dollars, like U.S. Treasury bills or weak currency-denominated debt. Given the economic turmoil in the U.S. and the widespread holdings of U.S. dollars, this factor is likely to continue to be a driving force be-hind the price of gold, at least in the near future.
The second factor, closely related to the first, is demand from investors and speculators who simply want to ―ride the curve.‖
Typically, this demand comes from
―investor fever‖ or from supportive technical analysis. This might also be seen as demand that feeds upon itself that has be
en made that much easier with the ad-vent of easily traded gold mutual and exchange-traded funds. This is the stuff of which bubbles are made. As seen in the graph on the next page, the meteoricrise in the price of gold since 2001 along with the corresponding increase in volume that really picked up with the advent of the current recession and has beenincreasing ever since, leads some technical analysts to conclude that a bubble is in the making and a correction may not be far behind.
The last factor I see is political and/or economic uncertainty. As gold is considered a ―safe haven‖ in times of stress, the
re seems to be little question but that thecurrent recession and political environment has played a role in the demand equation.If these are the factors that drive the price of gold, then it is important to recognize that they are all reversible. Again, unlike a traditional investment (stocks or bonds) that have inherent value and can be diversified to minimize the impact of specific security risk, the demand driven price of gold can reverse and stay negativefor a long time as actually occurred over the period from roughly 1980 to 2001. Therefore, any investment in gold should be watched carefully and restricted to a
manageable percentage of one’s portfolio.
 
Gold

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