June 7, 2013

Economic and Market Recap

L a n e A s s e t M a n age m e n t
Stock Market Commentary
since December 2008. While Europe stutterstepped through the rest of the month, U.S. equities continued to climb on the strength of consumer sentiment hitting a post-recession high and expansion of the Conference Board’s index of Leading Economic Indicators. The chart below reflects the positive May employment report. But here’s the interesting part. As the economy continues to make progress, albeit slowly, the FOMC April meeting minutes and subsequent speeches by some of the board members have begun to raise the specter of “tapering” or a slow down in Fed bond purchases which led a spike in interest rates in the last week of the month. This is interesting because earlier in the month, improving economic conditions drove the market higher. Now improving conditions, possibly leading to the Fed’s easing off the QE pedal, has led to the market weakening. In other words, investors want to see the economy improving, but not so much that it might lead to less support from the Fed. On other fronts, emerging markets took a tumble, oil lost all momentum and gold collapsed again after a brief recovery from April’s collapse. Investment Outlook
In no change from my outlook last month, as the economic headwinds have not subsided, I continue to think the prudent thing to do is keep risk exposure below one’s long term strategic allocation:
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After an initial gasp caused by the ADP emIs the bloom coming off the rose? The talk for the last couple of weeks is all about “tapering,” the word now being used to describe the Federal Reserve’s exit strategy from QE Infinity. When the FOMC’s April meeting minutes were released on May 22nd suggesting that tapering might begin later this year, interest rates spiked and the S&P 500 subsequently declined nearly 3% to-date. If nothing else, this demonstrates both the fragility of the market and concern investors have about the loss of Federal Reserve support. My own view is that the bloom is not yet off the rose. That said, given the market’s performance this year, I believe the risk remains to the downside. Be careful out there. ployment report falling below expectations and a drop in construction spending, May recovered strongly for U.S. and European equities as unemployment claims in the U.S. were the lowest since 2008 and the ECB cut interest rates as Europe remained in recession and manufacturing languished. Following the unemployment claims report, nonfarm payroll growth in the U.S. exceeded expectations, prior month job reports were upgraded and the unemployment rate fell to its lowest level

Lessen exposure to international sectors Increase exposure to safer, stronger U.S. sectors like consumer goods, utilities and health care Increase exposure to strong dividend payers.

One change from last month is that, with the spike in interest rates, I would hold off commitments to the multi-sector income arena until we have a better sense of interest rate movements and investor expectations. 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
Over the last couple of months, I’ve been observing the pattern of trend and momentum for SPY and relating that to the very similar pattern that occurred in the first quarter of last year with the thought that a correction was imminent. Now I’m wondering whether the current pattern is more closely related to the Fall of 2010 where upward trend persisted for a more comparable 6 months while momentum stagnated. Since we’re a little over 6 months into the current trend, looking strictly at the technical indicators, I suspect the

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current pace won’t go on much longer on technical considerations alone (see the next page). If we factor in the continuing r ecession in Europe and the weakening trend in corporate revenues, a correction may be only weeks or a few months away. Accordingly, rather than trying to squeeze out the last drop of gain, I suggest taking some risk off the table and paying even closer attention to those few sectors offering high quality and strong relative performance.

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

L a n e A s s e t M a n age m e n t
S&P 500
In a new focus for my technical analysis, the charts below show a short term (on the left) and a long term (on the right) “Raff Regression Channel.” The center line is the least-squares line (LSL) of best fit for the period covered by the channel. The outer lines are equidistant from the center line at the distance of the most extreme move during the period. (This may be more than you want to know.) The usefulness of this analysis, as I see it, is to have an additional mechanism to indicate the underlying pat-

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tern of price movement and also a mechanism to suggest when a technical correction bringing the price back to the LSL may be due to occur (as you can see, price does not seem to remain above or below the LSL for very long). Observing the charts below, I see the price breaking below the LSL in the short time period and coming off a high in the long timeframe. To me, this suggests the potential for a 6-10% correction over the next month or so. While past performance is no guarantee of the future, it will be interesting to see if history repeats itself here.

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.)
International equities, represented here by VEU, broke through the line of resistance at $47 in April only to be turned back at the next line at $48.50 in May. Sure, it was caused by the continuing recession in Europe but, as mentioned on the first page, the ECB lowered interest rates in May. So, I looked behind the numbers and found that the EU actually had a relatively small drop in May (see the chart on page 1) while other major regions (Latin America, China, India, and especially Japan) had a very bad month.

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Therefore, I would keep my broad international exposure low and be highly selective when investing in component parts.

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. As shown on the left, domestic equities continue to outperform investment grade corporate bonds. With the strong advance in May and the potential of an equity correction mentioned earlier, I expect this relationship to weaken in the coming days. On the right, we see that domestic equities fell behind international during April but took the upper hand again in May. Given the widespread challenges in the international equity markets, my inclination is minimize direct international exposure (a fair amount comes from domestic equity exposure in any event).

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. Following a period of relative weakness in LQD, both trend and momentum turned positive for investment grade corporate bonds in April only to turn south again in May. While bonds may do relatively well if equities experience a correction, I continue to believe there are more attractive income oriented investment opportunities, one of which is preferred stocks. While the relative performance of the preferred stock index fund PFF weakened a bit in April, strength came back to preferred stocks in May. In addition to preferred stocks, 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. A note of caution, however: Last month I indicated these alternatives might not be as affected by rising interest rates as would be corporate bonds. During the last week in May when rates spiked, some of these alternatives had a larger negative reaction than expected.

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) had another strong month in May and continue to outshine all other sectors save Europe. With a 30% gain over the last 12 months, I doubt whether the next 12 can be as successful. European equities (EZU) still look good on a 12 month basis, but lag the U.S. by over 35 percentage points on a 24-month basis, suggesting there may be a certain amount of catching up going on. On account of this lag, however, Europe has potential for another 12 months of strength despite its economic challenges. Gold (GLD) hit an air pocket in early April and, following a brief recovery, hit another one in May. I remain a non-fan of gold. Oil (DBO) backed off again in May, perhaps as a reflection of the difficulties in global economic conditions. Emerging market equities (EEM) slumped again in May following a brief recovery in April. EEM has remained basically flat since the beginning of 2010 while SPY has gained over 55% Investment grade corporate bonds (LQD) lost what little traction they had in April — first along with the strength in equities and then as a result of the spike interest rates at the end of the month.

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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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