December 9, 2012

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
tion how long this adjustment will last as some sectors recovered quickly (e.g., financials) and others have not (e.g. utilities). A study by Wells Fargo, citing a study by the Federal Reserve Board in 2005, found that the long run impact of tax law changes was shortlived. A second impact of the election was reaction to the expectation of higher taxes on long term capital gains. There is good evidence that selling pressure depressed prices, especially in the last few weeks. As can be seen in the chart below, much of this selling seems to have dissipated as investors found alternative (often equivalent) investments. The third significant immediate impact of the election has been concern over the fiscal cliff. Here, too, I think the issue may have run its course as investors seem to expect a settlement to have little impact on economic growth (which we can all hope for). Thats my expectation, too, though I doubt weve seen the end of volatility. Investment Outlook Last month I indicated that this may not be the best time to take on significant investment risk and Im sticking to that story. I believe the structural problems in the developed economies are far from resolved and will take more time to work through the system. However, that doesnt mean I would avoid equities and it doesnt mean that there wont be decent opportunities for gains in 2013 (more on that in my annual Fearless Forecast next month). As shown on the following pages, both large cap equities and investment grade corporate bonds have been performing well since the depths of the fiscal crisis. While I think gains will be more muted in the near future, Ive read well-regarded analysts who believe next year could be as strong as this year. Therefore, my recommendation at this point, with much depending on ones risk tolerance, is to stay the course with high grade equities and corporate bonds. There are a few other areas to be opportunistic, like municipal bonds, and well discuss those in greater length next month.

November was all about the election results This is my favorite time of the year, a time for family, friends and great food. Its also a time for me to be thankful thankful for the health and happiness we enjoy. I am also thankful for the indulgence of my readers who are kind enough to read my Commentaries and offer helpful suggestions and their own insights. But, this is not a great time for millions who are un or underemployed, who are hungry, or who are homeless (although knowing a few people in this situation, its amazing how well they keep their spirits up). So, this is a time to be thankful, but its also a time to do whatever we can to share our good fortune with those less fortunate. Talk about return on investment! Happy holidays to all. and the fiscal cliff. Interestingly, despite volatility, November finished nearly flat for the U.S. and emerging markets while Europe had a strong recovery. The first week of December, ending with a positive jobs report in the U.S., nevertheless did little for U.S. stocks. Regarding the election results, the biggest impact seemed on income-oriented sectors (utilities, financials, and preferred and dividend stock funds). The thought here was that the likelihood of higher taxes on dividends would depress their value to investors resulting in higher yielding securities. Its an open ques-

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
Following a hiccup on the heel of the election, SPY has not only recovered to its pre-election level for the time being, but it has turned the corner on important momentum indicators as shown in the bottom of the chart. An optimistic technical view would note the similarity of the moving averages and momentum indicators (in fact, the entire pattern over the last three months) to the pattern displayed last May, June and July and conclude there is opportunity to the upside. If thats all we had to go on, I would change my outlook to

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being more optimistic. But theres also the fundamental reality of intractable debt and employment issues in the U.S. and Europe. It also needs to be noted that a wide swath of economic indicators are far from robust. While my preference for fiscal policy is for stimulus paid for through revenue increases and elimination of outdated or inefficient current spending coupled with comprehensive tax reform in the U.S. (yes, I think entitlements also need to be addressed, but thats another story), Im not confident the political dynamics will take us there anytime soon. Therefore, I think the best course is to remain cautious overall and to balance equity exposure against tolerance for risk.

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

L a n e A s s e t M a n a ge m e n t
All-world (ex U.S.)
Defying every expectation, international equities have continued to climb, overcoming the negative momentum shown at the bottom of the chart. Where last month I attributed this more to selected countries in Asia, recently even certain countries in Europe are outperforming the broader international index (like Germany and Belgium). At this point, based on the chart below, there is every good reason to go green light on selected international stocks. On the other hand, the reason I remain cautious is that parts of Europe (Spain, Italy and Portugal, for example) as well other parts of the world (Brazil, for exam-

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ple) continue to show relative weakness compared to the broader index. Moreover, the continuing unemployment and sovereign debt issues in Europe remain quite worrisome. Therefore, the overall message is that while the broad international index is attractive at this time, investors may be better served focusing on individual country selection.

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 below, U.S. equities are turning the corner on investment grade corporate bonds an interesting outcome following the election, anticipation of which was showing up in late October. Since the reversal is relatively recent, increasing equity exposure should be done carefully and spread over time. On the right, international equities have continued their outperformance relative to U.S. equities. Its hard to tell if this is a technical recovery coming off the prior months of underperformance or an indication of fundamental strength (something I have a hard time believing for Europe). While the trend is clearly favoring international, the strong negative reading on the momentum indicators at the bottom suggest a nearing potential for reversal. Bottom line: given market uncertainty, a balanced approach may be best at this time.

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. Aggregate and Corporate Bonds

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LQD represents the total return (capital gains and interest income) for investment grade corporate bonds; AGG represents the total return of a composite of domestic government and investment grade corporate bonds and similar instruments (think of it as LQD but with government bonds). The chart on the right shows the relative performance of LQD to AGG which, except for brief periods, has been positive for most of the last two years, supporting the thesis of investment grade corporate bonds over government bonds. No change from last month: From a technical perspective, its hard not to like investment grade corporate bonds. Not only have the last two years been extraordinary, but this performance goes back to the early 80s when interest rates were at their highest. Yes, certainly a large part of the past performance can be attributed to the decline in interest rates and this is a phenomenon with a limited future, we can all agree. But with the index holding bonds of various durations, and with the Fed determined to hold short term rates near zero until mid-2015, the impact of rising rates (if occurring slowly) is likely to be more muted than many people might expect. In March and August, I was concerned about the extent to which LQD had gotten above its trend line which also showed up in the relative performance chart. In both cases, that problem was subsequently corrected and performance is back on trend. The picture looks similar at the end of September and some deterioration should not come as too much of a surprise. That said, investment grade corporate bonds continue to be attractive in an unsettled environment.

AGG is an exchange-traded fund (ETF) designed to match the experience of the Barclays Capital U.S. Aggregate Bond 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:

Following the two-month slide leading up to the election, the S&P 500 (with dividends included seems to be recovering. I would like to see this continue for at least another month before making a much large commitment to U.S. equities. Gold (GLD) slipped in October, seemed like it might be bouncing back, but has languished for the last six weeks. I still dont see enough evidence to make a major commitment to gold at this time. Oil (DBO) continues to slip as the worlds economies slow down and are confronted with even slower growth prospects. Both Europe (IEV) and Emerging Markets (EEM) have had parallel performance and both seem to be on the mend over the past several months. Europe has shown surprising strength and is now at a 12-month high. Investment grade corporate bonds continue their no-drama upward trend and are very close in performance to equities in the U.S. and Europe for the year.

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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.