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June 5, 2016

L a n e A s s e t M a n age m e n t
2015 Review and 2016 Fearless Forecast

Market Recap for May

Managing Expectations

May began on a weak note as U.S. nonfarm payrolls fell below expectations and

At the beginning of the year, my 2016 forecast was a very modest 3-5%

lack of productivity growth coupled with wage gains foreshadowed potential

growth in the S&P 500. While its too early to tell how accurate that predic-

stagflation and weakness in the GDP. The second week was brighter with retail

tion will turn out to be, there have been a number of recent research notes

sales coming in ahead of expectations along with a big rise in consumer senti-

that support that theme, two of which are:

ment. While the prospects for a fed funds rate increase overshadowed the mar-

ket during the first three weeks, those fears subsided as stocks rallied in the final

McKinsey & Companys April report (Why Investors Need to Lower


Their Sights) points to favorable economic and business fundamentals of

week on news that new home sales rose at their fastest pace since January 2008.

the last 30 years that are unlikely to be repeated. Not the least of these

First quarter GDP was revised to an annualized +0.8% in the second estimate, up

was an almost monotonically declining rate of interest on benchmark 10-

from the initial reading of +0.5%.

year Treasury bonds. As a result, according to McKinsey, where U.S. and

May ended on a sour note with the months nonfarm payrolls reported on

European equities and bonds for the last 20 years enjoyed a compound an-

June 3rd far below expectations, even after taking the Verizon strike into ac-

nual growth rate (CAGR) of about 8% and 5%, respectively, their forecast

count. A declining trend has been in place since October 2015. Note, however,

for the next 20 years is between 4 and 6.5% for equities and 2% for 10-year

that within minutes of the market absorbing the news with a sharp sell-off, equi-

Treasury bonds.

ties bounced back to a very small loss for the day probably on account of diminished expectations for a June fed funds rate hike.

In Janus Capitals June letter, Bill Gross (formerly of Pimco) uses a perspective similar to McKinseys by pointing out that asset returns for the last 40
years have been driven by declining interest rates, trade globalization, and
credit expansion, three areas that have reached or are very close to reaching their limit. Using historical equity risk premiums and an estimate for
bonds similar to McKinseys, Gross derives expected projected CAGR for
equities of about 4.5-6% for the next 10 years to which he attaches a
healthy dose of caution on account of distortions introduced by global
monetary and fiscal policies.

No one knows what the future holds in terms of investment returns. But its
hard to look back at the drivers of past returns and not conclude that a new
set of drivers will be needed for coming decades. My view is that major infrastructure spending is needed. Unfortunately, Washington does not yet agree.
The charts on the following pages use mostly exchange-traded funds (ETFs) rather than market indexes since indexes cannot be invested in directly nor do they typically reflect the total return that comes from reinvested dividends. 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

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S&P 500 Total Return


Its hard to tell, but theres a chance we may be about to experience dj vu all over again meaning, to me,
if focus is limited to the technical outlook, there seems to be an increasing amount of downside risk.
As we sit today, the current price pattern for the total return of the S&P 500 (SPY) is looking an awfully lot
like the pattern that played out from August to December of last year. One worrisome indicator is the similarity of the pattern of weakening momentum shown by the red arrows on the MACD at the bottom of the
chart. Another is the price resistance around $210 which has been in place for over a year and tested on numerous occasions (the flip side of
this analysis is that any sustained breakthrough above $210 should be taken as a very positive sign).
On the more optimistic side, we do have an increasing price trend in place and, while corporate profits have been weak, they remain positive;
consumer sentiment is rising; the growth rate in GDP retains a solid, if not spectacular, annualized growth rate of about 2%; and the market
seems to have reconciled itself to an increasing fed funds rate.

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

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S&P 500 The Longer Term View


Below is an updated 20-year weekly chart of the total return for the S&P 500 with a 60-week moving average trend
line and the momentum indicator MACD. The picture here is brighter than it was at the beginning of the year as
the long term trend channel held in the first quarter of the year. With recovery in the price trend and the beginnings
of an improvement in price momentum (MACD), the longer term outlook for the S&P 500 has to be called cautiously positive. The main question is whether or not the index can break through the price resistance around $210 in a convincing fashion. For
now, at least, the threat of falling outside the rising price channel has subsided.

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

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All-world (ex U.S.)


International equities, represented here by Vanguards all-world (ex US) exchange-traded fund VEU, followed the S&P 500 out of the doldrums at the beginning of the year, breaking through resistance at $41
but stalling around $44.25. With price trend and momentum beginning to weaken, Im not encouraged
about the prospects for the broad index. In addition, following an examination of exchanged-traded funds
covering different regions of the world, on the basis of the technical outlook alone, Im not finding a particularly compelling reason to encourage a region-specific allocation at the present time. One country that does seem to be
bucking the weak trend is India.
Add to that recent IMF forecasts for sluggish global growth, including severe headwinds for Asian economies (especially China), I believe the
international exposure of U.S. companies provides adequate global diversification without the added risk of a more focused approach.

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. As of 11/30/14, VEU was allocated as follows:
approximately 19% Emerging Markets, 46% Europe, 28% Pacific and about 7% Canada. 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

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Asset Allocation and Relative Performance


Asset allocation is the mechanism investors use to enhance gains and reduce volatility over the long term. 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 chart below shows the relative performance of the S&P 500 (SPY) to the Vanguard All-world (ex U.S.)
index fund (VEU).
In this chart, the relative strength of equities faltered in the first half of April but has since resumed with the beginnings of positive trend and
momentum. On a year-to-date basis, as of this writing, SPY has outperformed VEU by over 2 percentage points and has maintained positive
relative performance for virtually the entire year, so far.

SPY and VEU are exchange-traded funds designed to match the experience of the S&P 500, (with dividends) and the FTSE All-world (ex US) index, respectively. Their 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

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Income Investing
Investment grade corporate bonds, represented below by the exchange-traded fund LQD, experienced
an unexpected spurt in March and April for reasons that are not entirely clear to me. First, as shown below, the correlation between investment grade bonds and interest rates departed a long-running pattern
of negative correlation. At the same time, the correlation between bonds and equities (not shown)
swung into high gear with a well-above-average positive correlation.
The one thing I can point to for the rapid increase in LQD is the spurt in bond fund inflows that followed net outflows in 2016 prior to March, as
reported by Market Realist and Lipper. What I cant say is the degree to which this was a result of increased investor caution or a reach for
yield.

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

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Asset Allocation and Relative Performance


Following weakness in the first 45 days of the year, the S&P recovered its outperformance of investment grade (IG) corporate
bonds quickly in the subsequent 15 days and is showing rough balance for the last 3 months. My view is that, while I dont expect
great things out of equities, I have even lower expectations at least on a relative basis for IG bonds on account of the expected gradual rise in the fed funds rate and the benchmark 10-year Treasury bond rate.
On a longer term horizon, I expect the relative balance shown in the current pattern will be broken to the upside in favor of equities, but that
the degree of outperformance will be more in line with the approximate 3.5% annualized excess return for the period between 2014 and 2016, if
not lower, rather than for the period before 2014.

SPY and LQD are exchange-traded funds designed to match the experience of the S&P 500, (with dividends) and the iBoxx Investment Grade Corporate Bond Index, respectively. Their
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

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Income Investing
In this chart, we have the relative performance of the S&P U.S. Preferred Stock Index ETF (PFF) to investment grade corporate bonds showing relative strength of preferred stocks.
While investment grade corporate bonds have generally been inversely related to the 10-year Treasury yield,
the same has not been true for preferred stocks, especially those of financial institutions or REITs. In fact, as
shown below, there is a generally positive correlation between the yield on the 10-year Treasury bond and the
relative performance of preferred stocks to investment grade corporate bonds. With the expectation of a slowly rising 10-year
Treasury yield (despite recent experience) and the improving trend and momentum of the relative performance with bonds, I believe preferred
stocks offer an excellent alternative income-oriented investment.

PFF seeks to track the investment results of the S&P U.S. Preferred Stock Index (TM) which measures the performance of a select group of preferred stocks . 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

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Interest Rates
Shown below are the 2-year and 10-year U.S.Treasury yields for the last two years. The 2-year yield might be taken as a
proxy for the markets opinion about what will ensue for the Fed funds rate. The 10-year yield is a reflection of not only
domestic attitudes about changes in the Fed funds rate, but also the global interest rate environment and developing
strength or weakness in the U.S. dollar.
As you can see, both yields dropped precipitously in January, something I think few people, including me, expected at the
beginning of the year. Thereafter, the 2-year rate has been volatile as the expectations for a fed funds rate increase have wavered along with the
monthly employment reports. Most recently, while the market seemed to have accepted the likelihood of a rate increase in June, that view fell
away with the weak May employment report.
Meanwhile, the 10-year rate has been anchored by the major global government bond rates with the current 10-year rate for the U.K. at 1.35%,
Germany 0.14%, and Japan 0.1%. U.S.Treasuries continue to be seen as the safest bet among major country government bonds.

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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.

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 con-

Investing involves risk including loss of principal. Investing in interna-

tained herein or any decision made or action taken by you or any third party in reli-

tional and emerging markets may entail additional risks such as currency

ance upon the data. Some results are derived using historical estimations from available

fluctuation and political instability. Investing in small-cap stocks includes

data. Investment recommendations may change without notice and readers are urged

specific risks such as greater volatility and potentially less liquidity.

to check with tax advisors before making any investment decisions. Opinions ex-

Small-cap stocks may be subject to higher degree of risk than more es-

pressed in these reports may change without prior notice. This memorandum is based

tablished companies securities. The illiquidity of the small-cap market

on information available to the public. No representation is made that it is accurate or

may adversely affect the value of these investments.

complete. This memorandum is not an offer to buy or sell or a solicitation of an offer

Investors should consider the investment objectives, risks, and charges

to buy or sell the securities mentioned. The investments discussed or recommended in

and expenses of mutual funds and exchange-traded funds carefully for a

this report may be unsuitable for investors depending on their specific investment ob-

full background on the possibility that a more suitable securities trans-

jectives and financial position. The price or value of the investments to which this re-

action may exist. The prospectus contains this and other information. A

port relates, either directly or indirectly, may fall or rise against the interest of inves-

prospectus for all funds is available from Lane Asset Management or

tors. All prices and yields contained in this report are subject to change without notice.

your financial advisor and should be read carefully before investing.

This information is intended for illustrative purposes only. PAST PERFORMANCE

Note that indexes cannot be invested in directly and their performance

DOES NOT GUARANTEE FUTURE RESULTS.

may or may not correspond to securities intended to represent these

Periodically, I will prepare a Commentary focusing on a specific investment issue.

sectors.

Please let me know if there is one of interest to you. As always, I appreciate your feed-

Investors should carefully review their financial situation, making sure

back and look forward to addressing any questions you may have. You can find me at :

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.

www.LaneAssetManagement.com
Edward.Lane@LaneAssetManagement.com
Edward Lane, CFP

The charts and comments are only the authors view of market activity

Lane Asset Management

and arent recommendations to buy or sell any security. Market sectors

Kingston, NY
Reprints and quotations are encouraged with attribution.