September 5, 2016

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

Market Recap for August

Domestic equities and investment grade corporate bonds marked

home sales attained their highest level since October 2007.

increased in July and consumer confidence achieved an 11-month

time in August while international equities were more volatile and

high.

ended up somewhat higher. In general, the domestic economy is continuing to expand, if only slowly, while Europe struggles and China ex-

According to the ISM Report on Business on September 1st, the

The Feds Labor Market Conditions index turned positive for the

Housing starts reached their highest level since February and U.S.

According to Cumberland Advisors, the Bank of Japan seems

more likely to extend easing in September than not.

first time since December.

China reported Purchasing Manager Index values that showed expansion for the first time since November 2014.

overall economy grew for the 87th consecutive month.

The U.S. August employment report was soft enough to lead analysts to expect no Fed funds rate increase in September.

pands.

The Conference Boards Index of Leading Economic Indicators

While a decline in the Eurozone Economic Sentiment Indicator

suggests a slowing in the economy in the second half of the year,
the situation for ECB easing in the Eurozone is more complicated
on account of the governmental structure. This makes forecasting the likelihood of additional easing in the short term more difficult.
** *** **

With economic data looking constructive and central bank policy in

the short term seeming to be neutral to accommodative, the outlook for the market in the short term could be expected to be generally positive. On the other hand, as discussed on the next page,
the S&P 500 is heading into overvalued territory, if its not there already. My conclusion is that U.S. equities are due for a correction,
probably closer to 5% than 10%, but thats only a guess.
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
Market Valuation
The P/E 10 ratio (aka the Cyclically Adjusted
Price Earnings Ratio, or CAPE) is an alternative
calculation of the P/E ratio using a 10-year average
of inflation-adjusted earnings developed to overcome flaws in the traditional P/E ratio caused by
using current prices and recent quarterly earnings.
As shown in the top chart on the right, the P/E 10
is approaching 2 standard deviations from its mean
(average) value, a rare occurrence, or approximately where it was in 2007 just before the Great
Recession began.
On the bottom chart, in addition to showing the
P/E 10 well above its regression line, the chart also
shows the inflation-adjusted S&P Composite
(essentially the S&P 500) 90% above its long term
trend, another rare occurrence.
The economist John Maynard Keyes once said that
the market can stay irrational longer than you can
stay solvent. Thats another way of saying that the
market valuation (which, in part, can be explained
by stock buybacks), should not be used to time the
market but rather as one more data point to take
into consideration as investors consider their risk
tolerance.
** *** **

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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

The gains made in early July held through August with, up to now, no retest of support at $210. According to
the ISM Report on Business, despite recent contraction of manufacturing activity following 5 months of expansion, the overall economy grew for the 87th consecutive month and the more dominant nonmanufacturing sector grew for the 78th consecutive month. While U.S. home sales achieved their highest
level since October 2007, retail sales in July were flat vs. an expected 0.4% increase. While July nonfarm payrolls exceeded expectations, August payrolls fell short causing analysts to doubt a September Fed funds rate increase. As discussed on the prior page, the market valuation is becoming stretched.
Technically speaking, while the trend measured by the 100-day moving average (MA) remains positive, faster MAs have begun to turn negative.
This is also reflected in a weakening momentum (MACD) at the bottom of the chart below. A similar situation occurred in late April and May
and again in June which ended up being only mild corrections followed by significant price gain. My sense now is that a mild correction, say,
around 5%, is more likely than not, while a larger correction, say, on the order of 10%, is less likely on account of the general strength of the U.S.
economy. Caution is advised. Short term traders might take some money off the table while longer term investors should hold tight for now.

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 U.S.) exchange-traded fund VEU, enjoyed another strong month in August. Unlike July where the source of the gain was quite a few of the
emerging market countries, the gain in August seems to be largely attributable to China, Japan, and the
Eurozone, generally reflecting recovery from oversold positions. For the Eurozone, according to Capital
Economics, a somewhat downbeat outlook for the second half of the year may be being offset by an expectation of further easing by the ECB. For China, two official PMIs are pointing to expansion for the first time in 2 years,
possibly being fueled by credit easing.
Technically speaking,VEU presents a constructive picture. Like a swan in a pond, however, theres a lot of turmoil going on underneath the surface variation among countries and regions. While the broad index is looking attractive, I would supplement broad international weighting
with a tilt toward the Eurozone and China with a tighter rein than might be used for U.S. equities. While Japan is recently outperforming the
S&P 500, it has been performing in line with VEU and I see no reason now for a special 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. As of 8/11/16, VEU was allocated as follows:
approximately 19% Emerging Markets, 45% Europe, 30% Pacific and about 6% 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 weakness of U.S. equities relative to international equities began in July and continued through August. Both trend and momentum favor international equities at the present time, especially for the Eurozone and China. Not shown, however, is the relative strength of
the Russell 2000 (small-cap stocks) to international equities (or, for that matter, to the S&P 500.) While an allocation to international equities
would be warranted by their relative performance, it has not been typical in recent years for this to last more than a few months.

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
uncharacteristic advance in March and again in June and July, both times nearly coincident with the spike
downward for the 10-year U.S.Treasury yield, as shown in the chart on the right. The sharp increase resulted in a reduction of over 10% in the current yield for LQD. Since the beginning of July, LQD has more
or less stabilized as the 10-year Treasury yield has backed up from its all-time low.
The key question is, what does the future hold for interest rates. As the 10-year Treasury yield recovered
a bit in August, LQD lost momentum. From this point forward, as mentioned in recent months, the downside risk for interest rates appears to
be limited. Over the last couple of months, Ive had a suspicion that Treasuries and investment grade corporate bonds would begin to stabilize
despite the strong trend that had been underway. While this appears to be happening, its too early to call a trend. I believe theres also a risk
for a sharp reversal in LQD if traders believe a bubble is about to burst. One thing I am fairly sure about is that investment grade corporate
bonds appear to be a risky investment for a long term buy-and-hold.

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

A stalemate has developed in the relative performance of equities vs. investment grade corporate bonds. Accordingly, in terms
of an investors asset allocation, the recommended approach is to stick with ones strategic long term allocation. This is an unusually long period of standoff and history would suggest it will not last much longer. On the other hand, we are in a period of
managed interest rates, making the future that much less predictable.

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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Interest Rates
Shown on the left 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 increased in August, though not by much with
the 10-year yield now at 1.6%.
The U.S. 10-year rate has been anchored by the major global government bond rates with the current (at this writing) 10-year rate for the U.K.
at 0.602% (up slightly from last month), Germany at 0.048% (up from -0.1%) , and Japan at 0.018% (up from 0.11%). Can the U.S. rate fall below zero? While it is certain possible, I dont believe it will happen. Negative rates, or even rates as low as they are today, can have damaging effects on the economy if they remain low for a significant period of time on fixed income investors and on institutions with long term liabilities,
like insurance companies and pension plans.
On the right, we see the Treasury yield curve with a degree of flattening since January 2014, though we are still a long way away from the degree
of flatness generally associated with a recession.

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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

Lenox, MA
Reprints and quotations are encouraged with attribution.