February 9, 2013

Economic and Market Recap

L a n e A s s e t M a n a ge m e n t
Stock Market Commentary
was pure demand as investors poured record amounts into equities. The second week of January saw the largest inflow to equity funds since 2008. On the negative side was a lower than expected GDP report for the Q4/2012. But even that didnt slow the bulls for long as the details showed that some of the decline was due to slowed government spending following a more robust Q3. Investment Outlook
I believe the long term investment outlook remains positive. Earnings are beating expectations, the economic recovery continues to improve (even if not as fast as we would like), and government policy makers have proven that they are not quite ready to take away the punchbowl. We might even anticipate something good coming out of the sequestration (spending, or lack thereof) debate, though not without a certain degree of drama. The fact is, this seems to be a good market for both equities and income-oriented investments, though not all segments of either. The ultimate driver of equities, corporate earnings, continues to be positive and P/E ratios appear reasonable (though not so much for the normalized 10-year Shilling P/E ratio). On the income side, while government bonds are in bubble territory and investment grade bonds are sputtering, there are other income plays that remain quite attractive. The biggest concern facing investors today seems to be the pace of the market over the last 2 1/2 months, where the S&P 500 has gained nearly 12%, and the likelihood is of some steam coming out of the market in the coming weeks or months. No, I dont want to forget our friends in Washington. They are sure to trip things up along the way. But I dont expect those problems to be long-lived. For now, I would stick very close to broad equity indexes, both domestic and international. On the income side, I would look into preferred stocks, floating rate corporate debt and municipals.

January started off with a bang and never The future aint what it used to be, said Yogi Berra, and I think that might apply to the stock market, as well. As summarized in my 2013 Fearless Forecast, a number of analysts were predicting 2013 equity returns of 10%, more or less. Since January brought us nearly half way there, I think it would be optimistic, to say the least, to expect the current pace to continue. So, the question becomes. is there going to be a period of drift or might we see a more significant correction along the way. My feeling is the latter since this has been the historical pattern going back over many years. Should you be concerned? That depends on your long term outlook and your tolerance for volatility. looked back. As I reviewed the events of the month, what stood out was that there was a fair amount of good news and precious little bad news. On the good news side was a continuing story of companies reporting earnings beating expectations. Nearly 70% did so in the month, beating the statistical average by 8 percentage points. Economic data was also strong as December housing starts and jobless claims both beat expectations while China reported a surge in exports. Also driving stock prices

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 a ge m e n t
S&P 500
Last month, I recommended caution with regard to domestic equities not a lowering of exposure, but wariness about adding exposure in light of the run-up since last June and December. In addition, I was concerned about the strength in emerging corporate earnings and the dysfunction in Washington. On a technical basis, while the trend remained strong, the momentum seemed to be slowing. It turns out that, for January, at least, those concerns were unfounded as the market continued to plow ahead, corporate earnings ex-

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ceeded expectations, and tax rates were settled in the fiscal cliff negotiations. On a technical basis, trend overwhelmed momentum. Now, as we enter February, while trend remains strong, momentum (bottom indicators) is slowing and reaching levels consistent with a correction as was true last March and September. From a support/resistance standpoint, we are in uncharted territory as the index seeks a new line of resistance. My sense is to continue to advise caution about adding new positions. Even though economic indicators are generally positive, we are even more extended on the bull run and the jury is still out on the handling of the sequester in Washington. Its not impossible that the run continues longer, of course, but I wouldnt rush out to buy more domestic equities at this stage.

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 a ge m e n t
All-world (ex U.S.)
In some contrast with domestic equities, I was bullish on international equities last month. Trend was strong as was momentum, and international equities were outperforming domestic. While January was a good month for international equities and the trend remains strong, momentum has clearly slowed as the index approaches the next line of resistance around $49. As with SPY, the momentum indicators are at levels consistent with a pullback in prices. Therefore, I have moved to a more cautious stance with international equities basically a holding pattern until my expected correction occurs. As for individual regions, my advice is the same since there appears to be much consistency across the globe.

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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 a ge 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 bond index (LQD) on the left, and SPY to a Vanguard Allworld (ex U.S.) index fund (VEU) on the right. As shown on the left, domestic equities are strongly outperforming investment grade corporate bonds. So strongly, in fact, that a correction of some nature should not be a surprise as the momentum indictors are signaling an overbought situation. On the right, we see that domestic equities bounced back relative to international in January. Based on the change in direction for the momentum indicators, I expect domestic equities to extend their relative strength. This is not to say I would avoid international equities as they provide proper diversification only that it may be time to shift the allocation in the direction of domestic 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 no guarantee of future results.

L a n e A s s e t M a n a ge m e n t
U.S. Corporate Bonds and Preferred Stocks
LQD represents the total return (capital gains and interest income) for investment grade corporate bonds; PFF represents the total return of the S&P U.S. Preferred Stock index. Regular readers know that I have been very positive for investment grade corporate bonds for a long time as even hiccups have turned out to be brief interruptions to a continuing upward trend. In the past, I have not been concerned about the prospect of slowly increasing interest rates since I expected the

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turnover of bonds to those with higher yields to offset, at least somewhat, the impact of rising rates on the portfolio. Of course, another factor is at work, and that is investor demand. Whatever the reasons, its clear from the chart on the left below that the technical direction of LQD has turned south. And with that, I would advise caution as I believe there are better places to be in the income space. One of those better spaces is preferred stocks. As shown in the chart on the right, following a period of about 7 months of roughly comparable performance between LQD and PFF, the preferred stock index now seems to be taking control. But preferred stocks are not the only incomeoriented alternative to investment grade corporate bonds. Investors should look also into emerging market bonds, multi-sector bonds, floating rate corporate loans, REITs and other income strategies that offer a good counterweight to equities and are not as affected by rising U.S. interest rates.

PFF is an exchange-traded fund (ETF) designed to match the experience of the S&P U.S. Preferred Stock index. 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 a ge m e n t
12-Month Performance

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The chart below shows the last 12-month performance of the indicated ETFs, the same ones that are on page 1. The performance speaks for itself, but a few observations may be useful:

Large cap domestic equities (SPY) have had a very strong 12 months with a total return of nearly 15% only to be outdone by Europe (EZU) with a total return for the period of nearly 17% (though with a lot more volatility). Gold (GLD) slipped in October, seemed like it might be bouncing back, but has languished for the last ten weeks. While I acknowledge experienced analysts who recommend holding some gold within the portfolio, I cannot jump on that bandwagon. Oil (DBO) has recovered nicely over the last 2 months but not enough to give it a positive return for the last 12 months. Emerging Markets (EEM) lagged the U.S. and Europe in the first 3 months or so and have more or less paralleled since then, less so in January. Investment grade corporate bonds (LQD) have flat-lined and are actually turning negative in total return.

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L ane A s s e t M anage m e nt
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 Stone Ridge, NY Reprints and quotations are encouraged with attribution.