October 7, 2011

L a n e A s s e t M a n age m e n t
Stock Market Commentary
Market Recap Although taking advantage of calendar highs and lows, stocks just completed their worst quarterly decline since the first quarter of 2009. The losses were ubiquitous as 9400 mutual funds tracked by Morningstar turned in an average performance for the quarter of nearly an 18% decline. TheStreet.com reported that only 54 companies had positive returns in September. September opened with a net no new jobs report for August from the Bureau of Labor Statistics compared to an expectation of 93,000 new jobs. Fourteen million people remain unemployed and the average weekly hours worked slipped to its lowest level since January. And the economic news didnt get much better from there throughout the month. For what its worth, the second quarter GDP was revised upward to 1.3% from 1% (or back to its original estimate). Overall, my sense is that the European debt crisis is driving the day with little to no positive news elsewhere. As you view the charts below and on the following pages, note that I am now using exchange-traded funds (ETFs) rather than market indexes since indexes cannot be invested in directly and the ETFs are chosen to be as close as possible to the performance of the indexes while representing a realistic investment opportunity. Prospectuses on these ETFs can be found with an internet search on their symbol.

dropping nearly 18%. On the expectation of recession, oil (DBO) fell over 12% on top of its 10% loss last month. Silver (SLV) nose-dived nearly 29% following an increase in margin requirements by the Shanghai Gold Exchange (remember, this happened in April when the New York Mercantile Exchange did the same thing). Gold (GLD) followed suit with an 11% decline. As investors dumped equities, bonds (AGG) continued their slow but steady upward grind by adding marginally to their annual return. U.S. Treasury bond rates fell again to all time lows with 10 year rates dropping to about 1.7% before recovering to about 2% (a low not seen in 50 years) as investors continued their rush to safety. ___________ (cont.)

September was an ugly month, to be sure, and declined enough for me to conclude that, on a technical basis at least, this bear market may have further to go. And the fundamentals are not so rosy, either. Look around. The weakness in housing and employment, along with the European debt crisis and the U.S. political gridlock, remain more or less intact. Sure, at some point the market will be oversold, and we will be tempted to see things that way with every two-day market advance. If there is a positive spin to the current market, its that were probably closer to the bottom than the top. That said, Id be very careful about adding to risk exposure at this point. Comments are welcome. Ed Lane

The S&P 500 (SPY) wavered in the first half of the month but lost momentum in the second half, closing down nearly 7%. Emerging markets (EEM) fared worse,

L a n e A s s e t M a n age m e n t
Stock Market Commentary
Economic Outlook The economic outlook remains weak. Here are the factors that concern me the most (in no special order):

Political gridlock: Evidence continues to be absent for a break in the political gridlock in Washington. Bernanke recently said the recovery is close to faltering. Economic analysts have raised their expectations for a recessionary environment. Over the next few weeks and months, Congress and the Administration will have few opportunities (namely, the Super Committee and action on Obamas job proposals) to deal with employment and the long-term deficit before the 2012 election. Its hard to be optimistic on this front.

The market valuation is below trend (is this in anticipation of poor 3rd quarter earnings?) S&P 500 dividend yields are higher than the 10year Treasury yield.

Housing: The Case/Shiller index of property values is still over 4% below its level a year ago but has stabilized over the last 3 months. Since the figures from a year ago were inflated by special tax credits for new home buyers, the 4% decline may not be as bad as it seems. The pending home sales index declined 1.2% in August while the average price of new homes fell 8.5% (4.0% for re-sales) vs. a year ago. All in all, this shows a continuing struggle in the housing market. Employment: Following the weak jobs report for August, September jobs data came in a little better than expected but still weak. Returning Verizon strikers provided a bit of a boost that wont be repeated in next months report. July and August employment numbers were revised upwards, but not enough to make a big difference. European debt: The sovereign and bank debt crisis in Europe threatens the entire financial world. During September, there were several signs that European policymakers were taking hold of the problem, but hopes were dashed again as the steps being taken were observed to be inadequate to the problem. This drama continues to impact daily stock market performance. American debt: The U.S. also has its debt issues, both public and private. Speaking from a market perspective, the focus on reductions in government spending in the next several years cannot but hinder GDP growth and corporate profitability.

While I dont think the equity market will go gangbusters anytime soon, I do think there is an underlying growth factor that will be reflected in equity prices once effective policy action takes place. Repeating a comment from last month, long term investors might conclude that the current market slump presents a buying opportunity, and they may be right (certainly more so that last month). Unless you can stand the volatility, I would be very careful about adding equity exposure at this point in time and would limit my equity exposure to say, 20% or less, depending on circumstances. My current suggestions are:

Although I have low expectations for the economic outlook over the next several years, its not clear that we will actually experience a double-dip. And, despite the remaining deleveraging that still needs to be done, one aspect that gives me some hope is that effective policy action on the part of political leaders here and in Europe has the potential to change confidence virtually overnight. Will political leaders see their way clear to make the hard decisions necessary? Perhaps when conditions get bad enough or, as Winston Churchill once said, Americans (and we can add in Europeans) will do the right thing after they have exhausted all the alternatives. Investment Outlook The investment outlook has to be seen as shaky based on the above comments and the technical analysis on the following pages. On the positive side, however, are strong corporate balance sheets and an ability to find customers in emerging markets to replace the loss of customers in the developed markets, at least so far. Other reasons to be positive are:

High quality, dividend paying common or preferred stocks (not financials) For sectors, I like technology, consumer staples and utilities High grade corporate and government global bond funds, especially U.S. TIPs (inflationprotected Treasuries) For taxable accounts, municipal bond funds. (We are even getting to the point with closedend municipal bond funds that they may also find a home in deferred taxable retirement accounts on account of their current high yield.

Strong negative investor sentiment is often a good contrary indicator for the market

Be sure to check out the new asset allocation analysis on page 8.

L a n e A s s e t M a n age m e n t
Gold (and Silver)
As gold and silver have been such an important topic in investment circles, I thought it might be useful to provide a (slightly abbreviated) reprise of my comments from last month along with some new comments based on the events of September. First of all, it is important to remember that gold is not an ordinary investment. It does not have an earnings yield so its only value to an investor is determined by what you get back when you sell. The next important thing to remember is that gold has limited industrial use. That means the main demand for it comes from the love trade and investors. Although the love trade in Asia is growing rapidly and jewelry represents the largest current source of demand for gold, in my opinion, the price of gold lately is more influenced by investor demand (which also happens to be the fastest growing source of demand). From my perspective, an investor in gold needs to take into account both the technical analysis of its price direction and the fundamental factors that drive the demand. Typically, supply and demand have the greatest impact on commodity prices (rather than an underlying yield potential). In the case of gold, the supply is rather tight and is growing at a relatively stable pace and short of demand. That means, absent a supply shock and some exogenous event, that

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demand factors have the greatest impact on price. Based on my research, these factors drive the growing demand for gold:

is the action of the New York Mercantile Exchange that increased the margin requirements for silver in late April three times in one week and the Shanghai Gold Exchange that just increased the margin requirements for both gold and silver in late September. Both actions caused the respective markets to collapse overnight. So, we have the interesting condition that if the price of gold or silver rises too fast again, investors stand the chance that one of the commodity exchanges will change the rules again, leading to another price collapse. Another exogenous factor would be the impact of effective political action to address national debt issues (as unlikely as this might seem). If this were to come about, it could cause an immediate reversal in the demand/price for the precious metals or an immediate spike potentially leading to another adjustment in margin requirements. Ive been a fan of gold and silver in the past, but these factors have weighed on my thinking. Therefore, any investment in gold should be restricted to a manageable percentage of ones portfolio.

The first is a real or expected decline in the value of the currency that is exchanged for gold. In general, the price of both gold and silver have been inversely correlated with the value of the dollar. Real and expected declines in the value of the dollar have been a major source of demand for gold from individuals, institutional investors and central banks (who, according to Bloomberg, are the largest holders of gold), especially if they hold large quantities of other assets denominated in dollars, like U.S.Treasury bills or weak currencydenominated debt. The second factor is demand from investors and speculators who simply want to ride the curve. Typically, this demand comes from investor fever or from supportive technical analysis. This is the stuff of which bubbles are made. The last factor I see is political and/or economic uncertainty. As gold is considered a safe haven in times of stress, there seems to be little question but that the current recession and political environment has played a role in the demand equation.

In normal investments, the price of the investment is usually a function of supply and demand as well as the earning capacity of the underlying investment. However, as has been proven twice this year, the price of gold and silver are also subject to exogenous events. In this case, it

L a n e A s s e t M a n age m e n t
S&P 500
The S&P 500 (SPY) failed to get past the resistance level at 135 (think 1350 for the S&P 500 index) and has fallen to the support level at a value of about 112, a 17% decline and nearly qualifying for a bear market. On a technical basis, the 75 and 150-day moving averages are decidedly negative. Interestingly, the shorter term MACD indicator is showing an attempt to at least have a short term recovery while the longer term MACD shows continuing negativity. At this point, giving due regard to the economic and political challenges in the U.S. and other developed econo-

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mies, it is difficult to be enthusiastic about the near term prospects for the S&P 500. A technical recovery or spike on the heels of a good economic number (like the September jobs report) or positive news from Europe is likely. The key for the coming months will be the extent to which the political deadlock gets resolved and/or the strength of third quarter corporate profits that will come out in October. Since the 75day moving average has crossed over the slower 150-day average, I have become decidedly more negative. While 110 could represent a buying opportunity, I would be extremely cautious given the economic and political backdrop. Until something positive shows up, I remain in the red light mode. I would become much more interested if SPY dropped to 100 depending on circumstances at the time.

SPY is an exchange-traded fund designed to match the experience of the S&P 500 index. Its prospectus can be found online.

L a n e A s s e t M a n age m e n t
Emerging Markets
Similar to the S&P 500, emerging markets (EEM) collapsed in September, falling through its support at 40 and now pausing at its next level of support at 35. Since early July, EEM has fallen 27%, a definite bear market for emerging markets. The 75 and 150-day moving averages continue decidedly negative with the more ominous outcome of the faster 75-day average extending its differential with the slower 150-day average. Both the shorter term top MACD and the longer term bottom MACD are continuing their negative outlook. Given these technical indications, and with the economic issues confronting the developed market customers

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of the emerging market economies, I would not be comfortable making a significant commitment to emerging market equities at this time. As with the S&P 500 (SPY), some will see the current dip as a buying opportunity, and they may be right. To me, there are too many negative factors to go beyond putting ones toe in the water. Perhaps once the emerging markets shift to a greater focus on internal consumption rather than exports, conditions will be in place for a lasting recovery in these markets.

EEM is an exchange-traded fund designed to match the experience of the MSCI Emerging Markets Index. Its prospectus can be found online.

L a n e A s s e t M a n age m e n t
Barclays Capital Global Bond Index ETF
The Barclays Capital Global Bond Index ETF (AGG) represents the total return (capital gains and interest income) of a composite of domestic government and corporate bonds and similar instruments. (In the past, Ive used an global bond index. The U.S. index performs very similarly.) As shown in the chart below, this index has a steady upward momentum with very low volatility. It should be noted that the performance of the securities in this index have been a beneficiary of declining interest rates, producing capital gains along with interest income. As shown on page 1, the index barely moved in September. Observing the MACD, there is the ap-

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pearance of this index topping out, at least temporarily, so some caution is advised. For the portion of a portfolio where capital preservation has a high degree of importance and also to provide diversification, an allocation to a broad bond portfolio would be appropriate. That said, I would hold off for a little bit waiting see whether the MACD information turns into a reliable indicator of current weakness.

AGG is an exchange-traded fund designed to match the experience of the Barclays Capital U.S. Aggregate Bond Index. Its prospectus can be found online.

L a n e A s s e t M a n age m e n t
12-month Sector Comparisons
The chart below shows the 12-month performance of selected exchange-traded funds representing various market segments. Several observations can be made:

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The divergence between the U.S. and international markets may be giving an early indication of an opportunity with the international markets as markets normalize over time. Over the last 12 months, U.S. stocks have outperformed both emerging markets and Europe,. It will be interesting to see if this continues. Despite the decline in emerging markets, it is useful to note that EEM outperformed SPY over the last 3 years by over 10%. The more rapid decline of the last two years may simply reflect the convergence of the global experience of large U.S. companies and emerging market companies. Oil continues to back off, perhaps in anticipation of further declines in economic activity. Bonds continue to turn in a respectable performance with low volatility. Gold lost altitude in September with an increase in margin requirements imposed by the Shanghai Gold Exchange.

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 aggregate bond index (AGG) on the left, and SPY to emerging markets (EEM) on the right. On the left, we can see that the S&P 500 is currently underperforming bonds, although that underperformance may be coming to an end with a pattern similar to the August 2010 timeframe. To me, this suggests slowly moving up the risk spectrum relative to bonds. On the right, we can see the S&P 500 outperforming emerging markets, a pattern that began in August. Normally, this would suggest a heavier weighting to U.S. large cap stocks than to emerging markets but, considering the spike in the relationship in September and the weakening of the bottom momentum indicators, Id be careful about extending the domestic large cap allocation at this time until there is confirmation of the trend.

SPY, VEU, and AGG are exchange-traded funds designed to match the experience of the S&P 500, the FTSE All-world (ex US) index, and the Barclays Capital U.S. Aggregate Bond Index, respectively. Their prospectuses can be found online.

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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 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 Lane Asset Management P.O. Box 666 Stone Ridge, NY 12484