January 1, 2011

L a n e A s s e t M a n age m e n t
2011 Forecast and Stock Market Commentary
Happy New Year
Recap for December and all of 2010 Following hiatus in November, December turned into a strong month with the S&P 500 delivering half of its annual gain and emerging markets racking up nearly a third. During the month, many ecowhole exceeded the S&P by only about 25% (better in Asia/Pacific and worse in Latin America). Looking back, I think this might be explained by two factors: First, approximately half the profits for the S&P 500 companies come from abroad. So growth in emerging markets coupled with a decline in the dollar would naturally benefit the S&P 500 as well as emerging market stocks. Second, the equity performance of the more rapidly developing economies of the emerging markets over the last three years substantially exceeded that of the S&P 500. Therefore, when these economies began to introduce measures to contain their inflation, it was reasonable to expect their relative out-performance to diminish. So , what drove the markets in 2010? First, notice a high degree of correlation among the equity markets (especially the U.S., Asia/Pacific ex Japan, and Latin America) even though the total returns differed. In 2010, there were several macro and technical issues that seemed to have the greatest impact on the equities across the board:
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drifted out without interruption. Then, around mid-April, the markets took a nose dive as China took several steps to cool inflation. This caused concern to spread that other rapidly growing emerging economies would be following suit, potentially causing a global slowdown. Toward the end of June, markets began to recover as fears of a double-dip recession subsided with increasing industrial production and consumer confidence numbers. Markets cooled in November as the dollar gained strength against the Euro and concerns arose about falling exports as austerity measures were introduced in the U.K. and Europe. The year ended strongly in December as political gridlock took a holiday in the U.S., good economic news continued, and the world shook off China’s second rate hike. Gold continued in a “flight-to-safety” advance that began in the Fall of 2008 coincident with the bank bailout and other crisis maneuvers to stem the effects of the recession. Silver (not shown) had an even more dramatic rise of over 80% for the year. Through it all, global bonds did well most of the year as U.S. Treasury rates declined and short-term rates were held near zero. Then, when the dollar began to rise against developed market currencies at the beginning of November, interest rates reversed their downward course, bonds began to sell off, and bond values declined.

The great recession of 20082010 (and counting) has proven to be a challenging period for investing — and a learning experience. Most broad equity markets are still down substantially since October 2007, though they have substantially recovered since the bottom in late 2008. Today, the developed economies are confronting economic recession and soaring debt problems while the emerging economies are confronting growth-induced inflation. In both cases, level -headed solutions result in slowed growth, but it’s not clear that those will be applied in all cases. This adds up to the need for a more nimble and focused investment process in the coming year. Here’s wishing you a healthy and prosperous New Year. — Ed Lane

nomic indicators showed continued improvement and political gridlock in the U.S. gave way to bipartisan support for tax relief. On the other hand, fixed income investments and gold finished the month more or less where they started. The year as a whole was volatile. As shown on the chart on the next page, the equity markets took an early hit in January, advanced strongly until a sell -off occurred in mid-April, picked up steam through October and continued their upward march through the end of year. Looking at the S&P 500 alone, it advanced nearly 9% into April, then declined about 16% through July, then advanced nearly 23% to close out the year with a 12.8% gain for the year. Meanwhile, gold advanced more or less steadily throughout the year, closing up nearly 30% Global bonds advanced nicely through October, then lost steam to close out the year with about a 6% gain. Europe ended the year up about 2.3%. The surprising result for me in 2010 was the weaker than expected performance of the emerging markets. Despite GDP growth more than twice that of the U.S., emerging markets as a

Despite the general lack of serious bad news, the January dip, I suspect, was fear overcoming greed (also know as profit-taking) on the heels of the strong upswing over the prior ten months. (Are we looking down the barrel of the same gun today?) For the next two months, once the minicorrection had taken place, the “risk-on” trade was back as generally positive economic news

L a n e A s s e t M a n age m e n t
2010 Index Comparisons

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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
2010 Forecast Review
2010 Forecast — How did I do?
In what follows, I repeat my expectations for 2010 as they were provided in my Stock Market Commentary a year ago and provide a brief analysis on what actually occurred italicized in red. From last year, I said:
...I’m inclined to go along with the majority opinion of the market strategists, namely, that the U.S. market will be positive for the year with the best part of the performance occurring in the first half of the year. Following a weak January, the S&P 500 improved through mid-April, declined through June, and steadily improved through the end of the year, closing out the year near the YTD high. My 2010 forecast reflects the ying and yang of the U.S. market in 2010 as I see it.
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Sooner or later, as recovery appears to be more imminent (or deficits too large to ignore), the Fed will begin to withdraw liquidity from the system or, at least, signal that that moment is nigh. Ironically, when this happens, it’s likely to place a strain on the market as interest rates increase and credit conditions tighten. That said, I don’t expect this will occur much sooner than late 2010. Though concerns—and interest rates—are increasing, fiscal tightening has yet to occur in the U.S. Europe, on the other hand, is currently going through retrenchment in the wake of sovereign debt and bank credit problems and new austerity measures. Domestically, technology, large cap, consumer discretionary, basic materials and medical devices are likely to be among the best performers. Technology, consumer discretionary and basic materials all outperformed the S&P 500, while large cap (S&P 100) and medical devices underperformed. From a regional standpoint, emerging markets and Asia/ Pacific (excluding Japan, “AxJ”), though more volatile, are likely to outperform the S&P 500 and other developed markets for the foreseeable future. Both markets outperformed the S&P 500, but by less than 5 percentage points, and they were both more volatile.. I’m ambivalent about the dollar. Weakness is in U.S. interests in that it stimulates exports and fattens foreign -earned profits. On the other hand, as the Fed unwinds stimulus and deficit hawks gain the upper hand, rising interest rates will strengthen the dollar. Bottom line, I see the dollar strengthening by the end of the year. The dollar strengthened through mid-year, declined until November, then bounced back to end the year nearly where it began, up 1.3% above other developed economy currencies.. I have become less enthusiastic about gold. With “push me, pull you” influences and interest rate risk to the upside, gold’s expected performance is too unpredictable to continue my previous bullish stance. Gold did

extremely well in 2010, gaining 28%. I missed that one. Quality and high yield income securities of short and intermediate duration (conventional and convertible bonds and preferred stocks) will provide reasonable returns with limited volatility. That said, the prospect of increasing interest rates, could put these funds (especially investment grade) under price pressure. This turned out to be true with bonds and other income-oriented securities performing very well through October, then deteriorating for the balance of the year.. Despite stimulus, difficulties will remain in the domestic economy. Ultimately, the economy can’t fully recover until final demand is restored (consumer spending accounts for about 65% of GDP). Stimulus spending will support demand for a period of time, but no one believes that can continue indefinitely. The hope, I suspect, is that the stimulus will provide a catalyst for a more self-sustaining economy. We’ll see. I’d say this turned out to be true as unemployment remains high, the housing market remains in the doldrums and GDP growth remains below trend and typical post-recession levels. ...I expect new unemployment insurance claims to continue to decrease and the number of new jobs created to steadily increase, though not enough to bring the unemployment rate below 9% by year-end. Unemployment claims are decreasing, hitting a 2 1/2 year low in late December while the unemployment rate remains close to 10%. ...I believe the 10-year Treasury bond rate will continue to climb, perhaps to 4.5%, while consumer credit continues to contract, both unfavorable to the economy and the market in the short run, at least. The 10-year T-bond ends the year yielding just under 3.4%; outstanding consumer credit declined throughout most of the year with a bit of a spike at the end of the year.
** *** ** All in all, not a bad record.

On the one hand, stimulus payments and foreignearned profits will push the S&P 500 higher, perhaps even higher than conventional wisdom, to a range of 1200-1300. In fact, this rationale proved accurate and the S&P ended the year nearly1258. On the other hand, the brakes will come on when deficit reduction plans and activities become more clear and imminent. This occurred in Europe with a dampening impact on the markets, especially during April through June and toward the end of the year. The saving grace for the market in 2009 was massive global central bank intervention. Since over half of already approved U.S. stimulus remains to be distributed in the first half of 2010 and more may come, the stimulus will have its desired effect on consumption and will boost market performance. While the extent of the “boost” to the markets is arguable, many feel the stimulus did prevent a “double dip” recession. Deeper analysis supports positive economic results throughout the year.
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L a n e A s s e t M a n age m e n t
2011 Fearless Forecast
Fearless Economic Forecast for 2011
The Economies The three principal economies driving performance of investment markets are the U.S., Europe, and Emerging Markets (especially Latin America and Asia/Pacific excluding Japan). Here is my forecast for 2011. Bear in mind that, due to relative valuations, global commerce, geopolitical events (think Iran and Korea) and psychological factors (fear and greed), performance in the securities markets has not and will not necessarily comport with performance in local economies. For that reason, I separate my forecast of economic conditions from the forecast of investment market performance. The United States: Recovery in the U.S. will continue, but slowly. The recent passage of the extension of the Bush-era tax cuts and unemployment compensation, along with the reduction in payroll taxes, acceleration of deductions for capital expenditures, and other tax relief, will add to the GDP for the year as will strong corporate balance sheets when (if) they are put to productive use. On the other hand, housing, unemployment, and energy prices will be a drag on the economy, as will the wind down of certain provisions of the recent stimulus program. I believe we may see another leg down in home prices of 5-10% with risk to the downside as the number of foreclosures increase. The unemployment rate will remain high, above 9% for the year, with net new non-farm job creation increasing from the average level of about 81,000 for the first 11 months in 2010 to an average of about125150,000/month with the largest drag coming from the public sector, especially state and local government. Taking that all into account, my estimate for GDP growth is lower than many others and I peg it in the range of 3.25% to 3.5% for the year with the first half of the year being stronger than the second. Considering that this is a conservative estimate relative to others, the risk is to the upside. Interest rates will inch up with the 10-year Treasury bond yield ending the year between 3.75% and 4% with risk to the upside. However, I doubt the rate will go much past 4% without Fed intervention since this would put further strain on housing. I expect inflation as measured by the CPI to remain relatively contained, hovering around 1.5% with some risk to the upside. While I expect the dollar to slowly strengthen against the Euro and other developed market currencies, I expect it to weaken against currencies in emerging markets including China where I expect the Yuan will slowly appreciate against the dollar. Therefore, I expect U.S. exports to continue to improve, though not as rapidly as during 2010 and with headwinds from a slowdown in Europe and rebalancing economies in emerging markets. Politically (and this could be wishful thinking), I expect there to be a push for major tax reform starting with the president’s State of the Union speech (this would make it easier to deal with expiration of the Bush-era tax cut extensions in two years), a big step forward in plans for deficit reduction (though no major reduction in the 2011 or the 2012 budget), and new initiatives for education, energy conservation-related and infrastructure expenditures. Without these initiatives, the structural

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component of unemployment (about half of all unemployment) will remain disappointingly high. Overall, risk for the economy remains to the downside on account of potential underperformance relative to expectations, a continued high level of unemployment and home foreclosures, the spread of European debt problems, austerity measures in Europe and the U.S., and constraining policy actions as emerging economies address inflation concerns and rebalance to more domestically-focused economies. Europe: Europe has taken a stronger hand in dealing with its sovereign and bank debt crises than the U.S. by adopting public sector austerity measures in Greece, Ireland, France and the U.K. with more likely to follow in Spain, Portugal, Belgium, Italy and elsewhere. While this may be the absolute correct long term strategy, the result will be sub-par growth in the European Union and the U.K. in 2011. So far, Europe has avoided debt restructuring, but seems closer to taking these actions than anywhere else. I suspect, if the debt crisis spreads, that the ECB will continue to come to the rescue with monetary support in exchange for strong austerity measures. Surely, Germany will insist on this. Risk remains to the downside as the debt crises may not have fully materialized. Emerging Markets: I read recently that emerging markets encompass

L a n e A s s e t M a n age m e n t
2011 Fearless Forecast
more than 70% of the world’s population. It is projected that 2011 growth in the emerging markets (my focus is on Latin America and Asia/Pacific, excluding Japan) will exceed that of the developed economies in the U.S. and Europe, perhaps by as much as 100% or more, measured by the GDP. That said, their pace of growth will not be as great in 2011 as in 2010 owing to a decline in exports to the more developed economies and policy measPlease note that my investment forecast for the year is not a recommendation to make certain investments and hold them for the year. As Keynes said, “When the facts change, I change my mind. What do you do, sir?” Rather, the forecast could be used as a framework to orient investment strategy for the year while being prepared to make changes, if necessary, as markets develop. ures to address rising inflation. Offsetting these headwinds, emerging economies, especially China and India, will be focusing more in the coming year(s) on building infrastructure and domestic consumption, reducing dependency on exports. year, both up and down, beginning with a correction in the not too distant future as a result the 20%+ recent gain in the S&P 500 and excessive bullishness by individual investors (a contrary indicator). Since I do not believe there will be a “double-dip” recession, sudden declines of 10-20% should represent good buying opportunities. That said, I think the overall risk is to the downside on account of lingering recessionary problems in the U.S. and a lack of political will to make the substantial investments and debt reduction steps necessary to restore long-term economic health, the spread of the debt crisis in Europe, and inflationfighting in the emerging markets. In terms of sectors, I believe basic materials, technology and consumer discretionary are likely to be among the outperformers while utilities and health care will underperform. In terms of market cap, small and mid-cap will outperform large cap as M&A picks up steam. On the international front, I believe the best returns will come from India, Korea, Taiwan, Indonesia, Singapore, Malaysia, Chile, Peru, and, potentially, Germany while Europe as a whole will underperform. China and Brazil present an uncertain picture from an investment standpoint as a result of slower growth in exports and rising inflation; therefore, I think better opportunities are elsewhere for the time being. I was wrong to assume that emerging markets

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would substantially outperform the U.S. in 2010 and I’m not prepared to make that mistake again for 2011 given the extent of globalized earnings for U.S. companies. Therefore, I think these two broad markets will perform generally in tandem with a slight nod to emerging markets. Income-based Markets In anticipation of rising interest rates, it will be unlikely that income-oriented investments will do nearly as well as in the last few years. Therefore, I believe the best opportunities for this sector will be in those securities that benefit directly from rising rates, including funds that sell government bonds short and bank loan (floating rate) funds. In addition, preferred and dividend stock funds will do acceptably well with low relative volatility. Commodities and Precious Metals With strong growth in emerging markets, many commodities will do well. My favorites are copper and agriculture, both driven by emerging market growth. While oil performed well in 2010 and demand will be high in emerging markets, I would be cautious as increased prices will eventually choke off growth in the developed economies and may dampen further price advance. And, finally, despite the potential for a price correction, I like precious metals (gold, silver and platinum) as hedges for weakening currencies and a port in the storm in the event of global turmoil. If the 10-year Treasury rate rises much above 4%, I would lighten my exposure.

Fearless Investment Forecast for 2011
The Equity Markets Although the 30-year trend of total return for the S&P 500 is just under 8%, it is rare that the increase in a given year in that period was between 7% and 9%. More likely, the annual rate of change is much higher or lower depending on proximity to macro-economic events (market bubbles forming, bursting, and recovering). Since we are currently in a period of slow recovery, I am inclined to project above average growth in the S&P 500 for 2011, namely, to a range of 1375 to 1450 (about 9-15% increase). I think 2011 will be another rollercoaster year with an initial positive reaction to the recent stimulus program and the wear-away of the program depressing results later in the year. I also believe there will be sharp corrections during the

L a n e A s s e t M a n age m e n t
S&P 500 Index
The S&P 500 index continued the advance begun in July and handily exceeded the line of resistance at 1200 during December. On a technical basis, the 75– and 150-day moving averages are continuing their positive momentum and the MACD (another moving average-based momentum indicator) continues on the bullish move begun in July with occasional weakening along the way. The index is now approaching its next line of resistance at about 1300 which gives some reason for caution. At this point, I would feel good about the technical mo-

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mentum except for the nearly uninterrupted 20% gain in four months and extreme bullishness on the part of individual investors and many market pundits. Therefore, I would be cautious about adding to new positions and inclined to hold cash aside to take advantage of any significant correction.

The S&P 500 index is an unmanaged index which cannot be invested into directly. 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
Morgan Stanley Emerging Market Index

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The MS Emerging Market Index behaved similarly to the S&P 500 during December and continues the upward momentum it began in June. While the 75– and 150-day moving averages are retaining their upward slope, the MACD, a shorter term indicator, is non-directional following its collapse in November. I would be concerned about the 34% advance since June although there have been healthy corrections along the way, including one recently in November. Given the generally positive technical indicators and fundamental outlook, along with the recent correction, I will give a slight nod to portfolio additions with my main concern being the lack of support from the MACD.

The MSCI Emerging Markets index is an unmanaged index which cannot be invested into directly. 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
Barclays Capital Global Bond Index
The Barclays Capital Global Bond Index represents the returns of a composite of domestic and international government and corporate bonds and similar instruments. As such, it blends bond yields available globally along with the impact of currency fluctuations. As shown in the chart below, this index has had rather steady increases with a few periodic corrections. In fact, this index has been on an upward trajectory for at least the last 10 years as interest rates have declined. At this stage, with interest rates having reached historic lows, rates have started to firm and ―back up‖ causing the index to fall below its 75-day moving average while the MACD turned south in early November. Accordingly, and given my expectation of rising interest rates, I would avoid new commitments to

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bonds and consider taking some money off the table. Of course, for those holding bonds to maturity and just ―clipping coupons,‖ this analysis holds less relevance though I would not add new bonds to the portfolio at this time (there are more attractive income-oriented investments).

The Barclays Capital Bond—Global Index is an unmanaged index which cannot be invested into directly. 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
Gold and Silver
The chart below shows the 5-year monthly performance of gold and silver indexes along with a comparison of the performance of a U.S. dollar index. The chart shows an inverse correlation in the price of the metals against the value of the dollar except for the period November 2009 through May 2010 when the dollar advanced along with the price of the metals. The inverse correlation is understandable as the metals can be seen

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as an alternative to fiat currency. But other factors are clearly at play as the metal prices have advanced far more than the value of the dollar has declined. The primary answer, I believe, has to do with supply and demand imbalances along with global uncertainty. If that’s the case, then a good argument can be made for continuation of strong performance in these (and other) precious metals as long as governments (and others) around the world stockpile these metals as a hedge against future inflation. That said, as shown in 2008 and as suspected by some today, the value of the metals can be quite volatile and can contract rapidly. An interruption in the pace of price advances should not come as a surprise and may be a buying opportunity. Therefore, caution is advised when investing in precious metals.

This chart shows the performance of gold and silver indexes created by stockcharts.com that are intended to represent prices of the precious metals and is a very close approximation to the value of exchange-traded funds that hold these metals. The U.S. dollar index shows performance relative to currencies in other developed economies. These unmanaged indexes cannot be invested into directly. Past performance is no guarantee of future results.

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L an e A ss et M an ag em ent
Disclosures 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 Lane Asset Management P.O. Box 666 Stone Ridge, NY 12484

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