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Lane Asset Management Stock Market Commentary June 2012

Lane Asset Management Stock Market Commentary June 2012

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Published by Edward C Lane
Economic and stock market analysis for June 2012
Economic and stock market analysis for June 2012

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Published by: Edward C Lane on Jun 08, 2012
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May 7, 2012

Economic and Market Recap

L a n e A s s e t M a n age m e n t
Stock Market Commentary
June started off on Friday, June 1st, with a much worse than expected employment report in the U.S. along with increasing concern about rising yields in Spain and Italy. While the following Monday exposed weakness in U.S. factory orders, there were hints that Germany may soften its stand against Eurozone bonds that would be used to socialize European debt and relieve pressure. Tuesday brought more potential good news with a growing prospect for coordinated global policy action to forestall further economic slowdown. Wednesday was a red letter day with several Fed board members hinting at further easing in the U.S. helping the S&P gain over 2.5% (a technical bounce reacting to prior
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loss may have also played a part in the rally). Thursday started strong but ended essentially flat. Investment Outlook In terms of short term performance:

In May, equities suffered their worst monthly The news of the moment is the growing anticipation of further policy action in the U.S. and Europe to provide a backstop to the economies and to protect the European banks from insolvency. While I find supporting these actions easy considering the alternative, it needs to be remembered that these are artificial means to address a far more serious problem and sow their own seeds for future difficulties. The European and U.S. economies of roughly 1990-2008 were built on sand (debt). Restoration of broad participation in a thriving economy will require much more fundamental changes than can be offered by central banks around the world. loss in two years. The month opened up with weaker than expected employment numbers in the U.S. and was followed by a constant stream of negative news about the European debt situation (increasingly strong indications of a Greek default and departure from the EMU, record unemployment in the EZ with half the countries there entering recession, and potential failures of Spanish banks). Although this report is intended to be primarily about the month just ended, so much has happened at the beginning of June that I would be remiss not to bring it to your attention.

Markets are concerned about a global slowdown/recession and each day’s news that reinforces that view is met with further market deterioration While there is political concern about the potential long term expansion of sovereign debt, the markets are overjoyed to hear of government action to bolster economic growth and avoid bank failures (when the chips are down, we all become Keynesians) The back-and-forth of these messages are contributing to market volatility and the bi-modal nature of expected investment returns.

I believe we are at one of those investment crossroads where almost overwhelming fundamental headwinds are meeting the world’s best attempts at reversing the global economic slide. Frankly, up to now, policy actions have been short-lived and inadequate to the task. How an investor responds to the current environment depends on one’s risk tolerance and investment time horizon. My own view at the moment is that the downside risks outweigh the upside opportunity for at least this year, so invest accordingly. 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 observed that the pattern of price performance over the last couple of months was looking suspiciously like that in each of the two prior Springs. Even more telling, it seemed to me, was the reversal of trend that began in April along with the “wealth” of downside fundamental risk factors (sovereign debt, high unemployment, and political gridlock) that overhung the market. Accordingly, I advised not adding additional exposure to equities. That turned out to be the right call at that point in time. I also advised being attentive to additional deterioration in the market that might trigger the need to lower one’s

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risk profile. Now that we experienced that deterioration, what should be done now? From a technical perspective alone, using data as of the end of May, I would have to say it would be prudent to lower one’s exposure to equities at this point. On the other hand, two factors argue for some patience. First, there is the very sharp decline in May, the worst month in two years, that begs for a corrective bounce. Second, pressure is growing for central bank and government action to address the broader European debt crisis, especially in Spain (the potential next shoe to drop). Both these factors seemed to come into play on June 6th when the S&P gained over 2.5%. At this point in time, while the technical outlook is negative, I suggest the SOH (sit on hands) approach until we have more technical confirmation on market direction (which may come at any minute given pressures for policy action in Europe and the U.S.)

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 advised minimizing exposure to international equities on the basis of likely deterioration and turmoil in international equities owing largely to European debt issues and strong relative underperformance relative to U.S. equities, as well as the flashing red signal in the technical analysis. While the exact timing of the international decline could not have been predicted precisely, the advice was timely. As we sit today, little has changed in the European debt crisis despite early June discussions of potential support for Euro bonds and a bailout of Spanish banks. Fundamentally, with respect to its sovereign and

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bank debts, Europe can kick the can down the road by bringing more liquidity into the system and/or allow some degree of debt restructuring causing bondholders to take a haircut (however unlikely that is). With record unemployment and debt, Europe’s financial picture is not likely to improve for some time to come. From a technical perspective, the chart shows the index reaching a level of support around 35 at the end of May. On three prior occasions,VEU held at this level and we know now that the index bounced strongly on June 6th as the promise of European policy action met an extreme short term oversold market. At this stage, I would be reluctant to increase exposure to most international equities without additional confirmation of this price support. That said, on an historical basis, I can’t rule out that this isn’t a decent entry point for more aggressive investors.

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 I’ve 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. On the left, the S&P had a sharp reversal in May as equities sunk across the board. My preference for being below a strategic (long term) equity allocation certainly paid off last month with the relationship returning to close to “neutral.” That said, the steepness of the reversal made a bounce inevitable and one occurred on June 6th. Nevertheless, I maintain my stance to underweight equities relative to long term goals on account of the continuing macroeconomic headwinds. On the right, we see that U.S. equities continue to outperform international although the relationship is getting a bit extended and may be prime for a pullback. Except for the point made on the preceding page about international equities reaching a technical support level, I am not overly inclined to increase international exposure without further confirmation.

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. Aggregate and Corporate Bonds

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LQD represents the total return (capital gains and interest income) for investment grade corporate bonds; AGG represents the total return of a composite of domestic government and investment grade corporate bonds and similar instruments (think of it as LQD but with government bonds). The chart on the right shows the relative performance of LQD to AGG which, except for brief periods, has been positive for most of the last two years, supporting the thesis of investment grade corporate bonds over government bonds. From a technical perspective, it’s hard not to like investment grade corporate bonds. Not only has the last two years been extraordinary, but this performance goes back to the early 80’s when interest rates were at their highest. Yes, certainly a large part of the past performance can be attributed to the decline in interest rates and this is a phenomenon with a limited future, we can all agree. But with the index holding bonds of various durations, and with the Fed determined to hold short term rates near zero until late 2014, the impact of rising rates (if occurring slowly) is likely to be more muted than many people might expect. In early March, I was concerned about the extent to which LQD had gotten above its trend line which also showed up in the relative performance chart. That problem corrected itself later in March and performance in both charts is back on trend. The picture looks similar at the end of May and we know now that early June was a period of some pullback. That said, investment grade corporate bonds continue to be attractive in an unsettled environment.

AGG is an exchange-traded fund (ETF) designed to match the experience of the Barclays Capital U.S. Aggregate Bond 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.

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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 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 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 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 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.

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