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LFM Commentary December 2009

LFM Commentary December 2009

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Economic and Stock Market Commentary
Economic and Stock Market Commentary

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Published by: eclane on Feb 28, 2010
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December 2009

L a n e F i n a n c i a l M a n ag e m e n t
Stock Market Commentary by Ed Lane
The Trend Is Your Friend
Perhaps you’ve heard this investing expression before. In layman’s terms, it means “go with the flow” and old hands will remember the meaning behind “don’t fight the tape.” In essence, the implication is to ignore the “facts” (in quotes since my facts may not be your facts) and invest in the direction of existing momentum — the theory being that over a given period of time, security prices continue in a single direction until the weight of forces driving the market changes sufficiently and the direction reverses. the concept of technical momentum and relate that to the market during November. Momentum has meaning to those (like myself) who use technical analysis to inform investment decisions by measuring the rate of change in closing prices to detect trend strength and potential reversal points (it must be the actuary in me). Leaving aside for the time being how momentum is expressed and measured (there are many ways), the rationale (at least my rationale) for using it to assist in making investment decisions is that it strips away the causes of market movement and leaves behind a pictorial representation of the net effect of all forces working together. I find that particularly apropos today as there are so many competing theories about what is driving the market: excess liquidity (one of my favorites), corporate earnings, unemployment, inflation, recovery from being excessively oversold, exceptionally low interest rates, investors jumping on the bandwagon, geopolitical events, etc., etc. Taking all that into account, my momentum indicators remained positive in November and so went the market (even taking into account the Dubai-related market shock that occurred at the end of the month). Now, be careful. While the trend in the market continues to be positive, there are many indications that equities are reaching an overbought condition (yes, I know I’ve said that before) and some of these will be discussed in the pages that follow. As much as ever, investment posture should be guided by one’s risk tolerance and investment timeframe.

Special points of interest:

The market continued its upward trajectory in November following October’s breather

The economic messages are generally positive, but major long -term issues remain unresolved

Investing opportunities are limited. Caution is advised.

Inside this issue: The Trend Is Your Friend At-a-Glance Economic Recap Market Recap Technical Analysis My Bottom Line Disclosures 1

There may be no better proof that this investment concept holds water today
2 3 4-5 6-8 9 10

than what has happened in the markets since the recession began (or longer, if you care to look). But I get ahead of myself. I’ll explore this topic more on page 6 and even more in a special Focus to be distributed separately. Here, I’ll briefly remark on

Page 2

L an e F in anc i a l M ana ge me nt
Here is a one page summary of this month’s market commentary: The Economy The economy has had its ups and downs:
 

The reaction to Dubai’s plan to delay debt repayment shook the market at the end of November illustrating, I believe, the knife’s edge on which the equity markets rest

The unemployment rate rose to 10.2% while new initial claims for jobless insurance continued to decline

Emerging market equities reacted even more negatively to the Dubai announcement than did developed markets (following an correspondingly sharper rise in preceding months)

Nothing succeeds like the appearance of success. — Christopher Lasch, author

Consumer confidence, which is strongly correlated with consumer spending, has moved sideways since Spring and remains well below pre-recession levels

Gold, other precious metals, and domestic and foreign fixed income funds continue to show strength, possibly as safe havens for those looking to protect 2009 equity gains.

The Federal Reserve indicated it would hold interest rates low with no foreseeable plans for an increase while the 3rd quarter GDP was restated downwards from 3.5% to 2.8% (recall even that gain was largely a result of stimulus payments of one kind or another in the first place)

The Current Opportunities

Opportunities depend on risk tolerance and investment horizon Over the next year, income-producing investments appear most secure Longer term, best bets are Asia (ex Japan), emerging markets, building materials and technology.

The Conference Board’s Index of Leading Indicators continues to show improvement with a strong showing from the stock market and money supply components (the former is fragile and dependent on the latter, which itself may lack sustainability given that a primary source is government stimulus).

My Bottom Line I remain concerned about the prospects for the U.S. economy over the next several years but cautiously optimistic about the market as long as positive momentum holds. That said, there seems to be a growing consensus that the market has gotten ahead of itself. The sharp impact of Dubai’s recent announcement illustrates the market’s fragility — whether or not it portends more negative surprises to come.

The Market Here the news is mostly positive, if shaky:

After October’s pause, November continued the upward trajectory begun last March

While technical momentum indicators are still positive, they also give the appearance of running out of steam

Page 3

L an e F in anc i a l M ana ge me nt
Economic Recap
In general, the economic news for the month was positive, but the end of the month brought a shocker. The good news:

early-September of last year and are down sharply from the peak reached in March.

The recession in U.S. factory sector activity is over (at least for now), according to the data from the National Association of Purchasing Management which rose to 55.7, its highest level since April 2006.

The Chicago Purchasing Managers' Association reported that its November Business Barometer improved to the highest level since August of last year. According to Haver Analytics, during the last ten years there has been a 72% correlation between the Business Barometer and the three-month change in factory sector industrial production.

Statistics: The only science that enables different experts using the same figures to draw different conclusions. — Evan Esar, American Humorist

the not so good:

The second estimate of 3Q U.S. economic growth was lowered from the advance report due to slower growth in domestic demand and greater deterioration in the foreign trade deficit.

The gain in U.S. labor productivity improvement in the 3rd quarter was its strongest showing in six years.

Consumer sentiment declined again in early November, falling from October's 70.6 to 66.0, measured by the Reuters/ University of Michigan Index of Consumer Sentiment.

According to the Organization of Economic Cooperation and Development (OECD), composite leading indicators for September 2009 point strongly to growth in Italy, France, United Kingdom and China, while tentative signals of expansion have emerged in Canada and Germany. A recovery is clearly visible in the United States, Japan and all other OECD economies and major non-OECD economies.

The November event with the greatest potential impact on markets was Dubai’s announcement of its plan to request a standstill in its debt repayment. The action called into question not only the financial stability of Dubai, but of emerging markets generally (a reaction that I believe is overblown in most, but not necessarily all, cases). What’s not clear is whether this is the proverbial “canary in the coal mine,” or no more than an isolated and temporary shock as it appears to be as we enter December.

The Labor Department reported during the month that claims for unemployment insurance fell to their lowest level since

Page 4

L an e F in anc i a l M ana ge me nt
Market Recap
In the chart below, we see the year-to-date performance of several exchange-traded and closed-end funds representing selected investment sectors. In June, August and again in October, there were relatively short-lived corrections on the continued advance upward. Since I admit to my reservations about the substance more to profit-taking than as an indication of fundamental weakness in these markets. Notice also, the essential lack of reaction to the Dubai Announcement in the fixed income space — corporate and high-yield bonds — where there is some evidence of a flight to safety. In fact, I would not be surprised to see this transition continue through the balance of the year as 2009 gains are locked in by investors and fund managers. Though it is too early to see hard evidence of this in the equity performance below, David Rosenberg of Gluskin Scheff reports that “over the past six months, U.S. investors have put a net $26 billion into equity funds while plowing $254 billion into bond/hybrid funds.”

Be thankful we're not getting all the government we're paying for. — Will Rogers

and potential extent of the economic recovery in the U.S., I see these minor corrections as warning signals of a fragile market. In November, upward momentum continued until the Dubai announcement the day after Thanksgiving. Notice the sharper decline in Asia (ex Japan) and Emerging Markets compared to the developed markets in the U.S. and Europe which I believe is due

A prospectus for the above funds can be obtained through this website: http://moneycentral.msn.com/investor/research/etfs.aspx

Page 5

L an e F in anc i a l M ana ge me nt
Market Recap (cont.)
Looking at selected bellwethers in the chart below:
 

The Consumer Discretionary sector is showing surprising (at first blush) steady upward momentum. A look behind the scenes, however, shows that companies the likes of McDonald’s, Walt Disney, Comcast, Amazon and Target are among the top holdings — not really high-priced product companies — making the sector’s performance more understandable.

Gold, global building materials and technology continue to demonstrate strong momentum and, at least so far, are unaffected by the Dubai announcement

Financials and real estate seem the most precarious where both have trended sideways for the last four months

I think we agree, the past is over. — George W. Bush

A prospectus for the above funds can be obtained through this website: http://moneycentral.msn.com/investor/research/etfs.aspx

Page 6

L an e F in anc i a l M ana ge me nt
Technical Analysis
Quoting from the Journal of Indexes regarding investment in currencies but applicable to other investments: “Fundamental analysis explains currency movement in terms of macroeconomic variables such as growth, inflation, monetary policy, etc. One of the weaknesses of fundamental analysis is that it says very little about the timing of moves and risk management. Timing is an important part of risk management. Even rudimentary technical analysis can help investors fine-tune their entrance into an investment and help quantify the risk. Monitoring the price action itself will likely reveal a higher probability of successful opportunities….” I agree. Here is a brief technical analysis for December: On the chart of the S&P 500 index on the top of the next page:
 

the beginnings of a market reversal but turned back north in July. At the beginning of October, the indicator began to change course and appears to be weakening once again. The resistance line at 1000 has been handily exceeded and now forms a support to a potential correction. The second chart shows comparable information for the MSCI Emerging Markets index. Notice the even more positive indications of the EMAs on this chart. The resistance line at 950 was broken twice in November as the index struggles to get by. On the top of page 8, another chart shows a nearly 30-year weekly measure of the percentage change in the S&P 500 index along with a 45-week EMA. Notice how well the percentage change continues its progress in a given direction as long as the slope of the EMA does not change. While past performance is not a guarantee of future results, buying and selling at the inflection points would have produced returns much better than a buy-and-hold. On page 8, we have a chart illustrating the performance of the S&P 500 index (in black) compared to the percentage of stocks within the index that are above their 150day moving average (in red). Being above 90% has been a warning signal of potential correction. This past month, the percentage has dropped to about 85%, letting some steam off. If past is prologue, and it is not necessarily so, we can expect a further decline in the not-too-distant future.

Experience is a hard teacher because she gives the test first, the lesson afterwards. — Vernon Sanders Law, retired Major League Baseball pitcher

Momentum, as measured by 75- and 150-day exponential moving averages (EMA), remains positive.

The spread between the daily price and the 75-day EMA is narrowing such that a relatively small correction would begin to violate that indicator. This would not be too difficult a feat and the narrow spread begins to raise a warning flag.

The MACD (another indicator used to measure direction and strength of momentum) accurately showed an extreme oversold situation last November and again in March. In June, MACD showed

Page 7

L an e F in anc i a l M ana ge me nt
Technical Analysis (cont.)

The secret to creativity is knowing how to hide your sources. — Albert Einstein

The S&P 500 and the MSCI Emerging Markets indexes are unmanaged indexes which cannot be invested into directly. Past performance is no guarantee of future results.

Page 8

L an e F in anc i a l M ana ge me nt
Technical Analysis (cont.)

Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. — Will Rogers

The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.

Page 9

L an e F in anc i a l M ana ge me nt
My Bottom Line
I remain concerned about the U.S. economy and cautiously optimistic about the market. Here’s why I’m concerned about the economy:

The employment situation remains bleak and there does not appear to be forthcoming the structural industrial changes needed to absorb the unemployment overhang on a long term basis. Current government stimulus, and fiscal and monetary policies generally, while helpful to many, will not cause the “escape velocity” for sustained economic growth. In other words, domestic growth seems to be built on a combination of government stimulus, a weak dollar, and cost cutting, none of which are sustainable over the long term.

(FOMC) minutes and see the wide divergence of views over the macro outlook, and this is coming from 17 of the nation’s top policymakers who also ostensibly keep in touch with each other. The range on 2010 GDP estimates is: 2.0% to 4.0%; for 2011, 2.5% to 4.6%, and 2.8% to 5.0% for 2012. These two percentage points are huge…”. And here’s why I’m cautiously optimistic about the market:

My dog is worried about the economy because Alpo is up to 99 cents a can. That's almost $7.00 in dog money. — Joe Weinstein, author

The stock market is much broader than the U.S. economy and there are many opportunities for diversification. Continuing dollar weakness enhances certain international markets as well as reportable profits for U.S. companies with overseas operations.

While the period since March was characterized as a return to risk as a flood of cash flowed into equities and lower grade fixed income securities, that pattern may now be reversing (for example, PIMCO increased holdings of government bonds in its very successful Total Return Fund to 63%, its highest proportion since mid-2004).

The flood of cash from stimulus programs worldwide not only stimulates economic activity, but demonstrates the commitment that exists to avoid further catastrophe.

Emerging economies are beginning to reduce dependencies on export led growth.

Conservative investors and that portion of portfolios that represents shorter-term investment should consider higher grade domestic and foreign income producing securities. While a longer term or more risky focus might look to emerging markets, technology, and infrastructure/building materials, immediate caution is advised as these markets may be in the process of “catching their breath.”

Technical indicators, still showing positive momentum, seem to be running out of steam. Admittedly, we have seen this pattern several times since March.

The Fed’s recent announcement to keep interest rates low for the foreseeable future suggests a low opinion of selfsustaining economic growth. In fact, as reported by the investment management firm Gluskin Sheff, “just go to the Federal Open Market Committee

Page 10

L an e F in anc i a l M ana ge me nt
Lane Financial Management is a Registered Investment Adviser with the States of NY, CT and NJ. Advisory services are only offered to clients or prospective clients where Lane Financial Management and its representatives are properly licensed or exempted. No advice may be rendered by Lane Financial Management unless a client service agreement is in place. Stock 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 Financial 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 one’s overall risk tolerance and financial objectives.

In the eyes of public opinion, the contrarian investor faces a loselose proposition. When contrarian approaches fail to keep pace with the current market darling, morefashionable players mock the out-of-step thinker. When contrarian approaches surpass the alternatives, consensus-oriented players decry the irresponsibility of the unconventional investor. — David Swenson, Yale University Endowment Fund Portfolio Manager

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.LaneFinancialManagement.com Edward.Lane@LaneFinancialManagement.com Lane Financial Management P.O. Box 666 Stone Ridge, NY 12484 917-575-0299 Reprints and quotations are encouraged with attribution.

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