December 7, 2013

Economic and Market Recap

Can it be? Are we turning a page? This past year has seen equity prices react somewhat poorly to positive economic news when that news was linked with a sooner-than-hoped-for decision to reduce bond purchases under the Feds QE program. November and the beginning of December looks different. While Yellens appointment keeps dovish attitudes in play, we also saw very encouraging economic news in better-than-expected payroll growth, new home sales, factory activity, construction spending and consumer confidence connected to a rising market. It may be too early to break out the champagne but we may be watching a transition to a more fundamentally-driven market as the economy reaches escape velocity.

L a n e A s s e t M a n age m e n t
Stock Market Commentary

As noted in the sidebar, it may be possible that the driving force behind equity market gains is shifting from the exogenous effects of the Federal Reserves quantitative easing program to a belief in the sustainability of more endogenous fundamental issues of economic growth. Im just sayin. Here are some highlights of the factors influencing Novembers equity performance:

The S&P 500 experienced a 1-day hiccup on the 7th as stronger than expected U.S. growth raised fears of early tapering, but one day later much-better-than-expected job growth and high-than-expected Q3 first pass estimated GDP growth of 2.8% erased the prior days relapse. Dovish testimony from Janet Yellen in her confirmation hearings in the middle of the month reminded us that QE still has its influence as the market set new all-time highs. Carl Icahns downbeat message on the

18th along with some Fed taper talk shook out some weak hands as the market quickly bounced back to set new highs in the 3rd week. The market drifted lower at the end of the month as the turkey was digested only to be followed in the first week of December with much-better-than-expected payrolls and revised estimated Q3 GDP growth of 3.6%. Investment Outlook As positive 2014 analyst predictions are starting to emerge, my longer term outlook is cautiously optimistic. That said, I think a small correction here would be healthy. With little change from last month (Ive dropped emerging markets), as of this writing there are still areas of relative outperformance, including:

The month began with better than expected data on U.S. and China manufacturing activity.

Healthcare, especially biotech Consumer discretionary and industrials Large cap value International developed markets, especially Europe (though I still favor the U.S.) While investment grade corporate bond returns are skimpy in comparison to recent years, short term high yield bonds and floating rate loan funds offer the best opportunity in the income space.

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 said except for being a little overbought on a short term basis and susceptible to a correction of 3-5% or so ..., Id have to say that equities are looking pretty good with a rising trend line and improved momentum with the change in direction for the MACD. My larger concern from a technical perspective, however, is that the long-term trend is overbought. Well, the correction didnt occur and the analysis held with the S&P 500 having a terrific month, adding 3% and handily beating the other sectors I follow on page 1.

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So, how does the market look now? On the basis of the chart below, I have a little more concern about a correction than I had last month. On the positive side, SPY is clearly on trend with a rising 50-day moving average (50DMA) and the price right in the middle of the trend. Not shown but also positive is a rising flow of money into the S&P. On the other hand, momentum (MACD) is at an overbought level and starting to turn negative. My suspicion is that this could be the beginning of a mild correction in light of the rich market valuation and relatively strong performance over the last 8 weeks. Therefore, I am going to maintain my cautious yellow light stance. Investors need to evaluate their tolerance for risk as the market plows ahead.

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
S&P 500The Longer Trend
Below is a picture of a longer term (12 year) trend for the S&P 500 (with dividends reinvested), with a spread from the top of the channel to the bottom of about 17%. In this view, SPY is near the top of the drawn channel for the 6th time in over 4 years, with each time resulting in a correction twice 15-17% and the rest of the time, about 4-7%. What concerns me is a possible repeat of the experience in 2010 and again in 2011. On the other hand, while momentum (MACD) softened a bit this past summer, it is currently still rising, unlike those prior

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times. This market optimism is seen by some as a contrary indicator (theres always an explanation to support one side of th e argument or the other). My interpretation is that there is good reason to keep exposure to equities at or below ones long term strategic al location, reserving some fuel for the next hiccup.

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, are continuing to show characteristic volatility but have now stalled with weakening trend (the 50DMA) and even greater weakening in the momentum (MACD). With the recovery that occurred in early September and again in October, price broke through resistance around $48.10 but is having trouble getting much past that point. At this stage, $48.10 has become a new line of support.

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As Ive mentioned in the past, international equity performance can be very localized. Currently, Germany, Mexico and parts of Asia are outperforming the broader index, but not much else. Most of the emerging market countries are running behind VEU. Remembering that maybe 33% of the revenue of the S&P 500 come from overseas, significant international exposure can be had through a completely domestic allocation.

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 Ive 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 (IGC) bond index (LQD) on the left, and to the Vanguard Allworld (ex U.S.) index fund (VEU) on the right. Bouncing off of support in early October, equities remain in an up channel relative to IGC bonds and the relationship is still on trend. Despite the weakening momentum shown on the bottom of the chart, I suspect equities will retain their relative strength for the foreseeable future even if there are a few hiccups along the way. On the right, domestic equities regained firm control over the broader international index though an analysis of the relationship with European equities, especially Germany, (also parts of Asia) shows a different picture and a much more even level of performance, highlighting the need to be very country-specific when investing in international equities.

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 Corporate Bond Index, respectively. Their prospectuses can be found online. Past performance is

L a n e A s s e t M a n age m e n t
Income Investing
While income investing has gotten a bad name in the last few months as the reaction to the Feds contemplation of tapering its bond purchase program in May resulted in a spike in interest rates, that does not mean the sector should be abandoned altogether. In prior months, I spoke of the outperformance of pre-

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ferred stocks to investment grade corporate bonds. As in recent months, I draw attention to short term high yield corporate bonds represented here by PIMCOs exchange-traded fund HYS. On the left below is a 2-year chart of total return for HYS. Over the last 2 years, the annualized gain has been about 9.1%; about 8.5% over the last 12 months. The chart on the right below contains the relative performance for HYS vs. investment grade corporate bond index fund (LQD) showing their similarity of performance during a period when LQD was rising last year, but significant outperformance since the first of the year as LQD has faltered. As I indicated last month, while the relationship looked like it was about to reverse in favor of LQD in October, that hasnt happened, at least not yet, and appears unlikely as I doubt well see much more interest rate decline.

HYS is the PIMCO 0-5 Year High Yield Corporate Bond Index which seeks to correspond to The BofA Merrill Lynch 0-5 Year US High Yield Constrained IndexSM*. 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
Treasury Rates

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This chart shows the percentage increase in 1, 5, and 10-year Treasury rates since the beginning of the year. In percentage terms, rates skyrocketed in August and the first week in September with the 1 and 5-year rates increasing over 20% during the period while the 10-year increased nearly 10%. Since then, following a period as rates settled down, the 5-year rate is inching up to its September high while the 10-year also appears to be gaining ground as it has added over 20 basis points since last month (2.88% as of this writing vs. 2.65% last month). While some bond managers I read suggest theres more downside to Treasury rates, I dont see that yet in the charts. Since the outlook remains for higher rates longer term, I would suggest investments in income-oriented securities should keep durations short, say, under 5 years.

L a n e A s s e t M a n age m e n t
12-Month Performance
The chart below shows the last 12-month performance of the indicated ETFs, the same ones that are on page 1.

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Large cap domestic equities (SPY) plowed ahead again in November with the another improvement in the rolling 12-month performance. Continuing this performance next month will be more challenging as the chart will lose almost 5% from a year-ago December. Along with its weakness last month, the Euro Zone (EZU) lost about 7% from November 2012 in last months chart resulting in a loss of 12-month leadership relative to the S&P 500. Note that the broader international index VEU (not shown) remains below SPY for the 12 months, highlighting the outperformance of EZU vs. VEU by over 10 percentage points for the period (same as last month). Gold (GLD) continues to languish. If gold represents the fear trade, theres not much of that evident and, I suspect, that w ill continue. Oil (DBO) lost a little more altitude in November as tensions eased in the Middle East. Next months chart will be challenging as DBO will lose about 6% from its rolling 12-month average. Emerging market equities (EEM) had another flat month in November. As with the other equity ETFs, next months rolling average will be challenged by the loss of strength from a year-ago December. Investment grade corporate bonds (LQD) continue to struggle as investors anticipate rising rates. Eventually, turnover in the underlying bonds and stabilization in rate expectations will lead to recovery in LQD, but that doesnt seem to be on the near term horizon.

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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 ones overall risk tolerance and financial objectives. The charts and comments are only the authors view of market activity and arent 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 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 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 Kingston, NY Reprints and quotations are encouraged with attribution.