April 2, 2013

Economic and Market Recap Are U.S. equities in another bubble? Yes, I think they are, if for no other reason than the 4 month uninterrupted advance. If thats all there was, a typical correction would be around 10% and recovery would be 2-6 months. But there may be more to this bubble than that. The kind of bubble we may be developing now, and one of greater concern, could be more like the ones in 2007 and 2000 in that the market is being propped up by something that cant last this time Federal Reserve intervention. Clearly, the Fed will do everything it can to soften its exit strategy and it may be years away. However, when big market participants sense the winds changing, we could be in for another rocky ride.

L a n e A s s e t M a n a ge m e n t
Stock Market Commentary
But March was a good for the S&P. The month started off with very favorable payroll numbers and a decline in the unemployment rate. As the month progressed, initial jobless claims dropped to their lowest level in the post-recession period, the Fed reiterated its bond purchasing program, single family housing starts were the highest since June 2008 and consumer confidence surged. Oil had a good month, but has still not recovered to its January high and gold attempted a bit of a recovery. On the other hand, Europe was brought low by the Cypriot financial crisis and Emerging Markets still havent gained any traction this year. Investment Outlook
Not backing off my long term positive outlook for the market (actually, the U.S. equity market), we may be approaching nosebleed territory. Following a 3-month rather steady rise of 10% for SPY, we have achieved almost all of the gain (or more) anticipated by optimistic analysts at the beginning of the year. To expect no serious correction over the next couple of months would go against the experience of most years. Yes, the market could still close higher this year, but I think not likely without a hiccup along the way. As I said last month, investors should anticipate that a correction is likely to occur, perhaps 10% or more, before the end of the year. No one really knows if that will occur, but there is strong historical precedent as well as technical indication. If that is unnerving, then risk should be taken off the table. As we sit at the beginning of April, heres what I would suggest to soften a potential future blow yet still participate in some market improvement:

It was a heckuva month. The Dow Jones index reached its highest level since 1998 and the S&P 500 index reached its highest point since the high reached in October 2007 (although, truth be known, if reinvested dividends are counted, the S&P reached a new all -time high a year ago) But before we get too excited, lets remember that the S&P 500 index, with reinvested dividends, is less than 13% higher at the beginning of April than it was at the October 2007 high, for about a 2.2% annualized gain.

Lessen exposure to international sectors Increase exposure to safer, stronger U.S. sectors like preferred stocks, utilities and health care Increase exposure to broadened, multi-sector income strategies.

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
Well, once again, the long anticipated market correction didnt occur in March. In fact, both the Dow Jones index and the S&P 500 (with and without reinvested dividends) set new records. Looking at the chart below, after hitting a triple bottom in August-October 2011, the S&P has been on an upward trajectory, with a breather taking place a year ago, resulting in a total gain of almost 50% in the 18 month period. Keeping in mind that the S&P (SPY) has gained only 13% since October 2007 (a figure remarkably similar to the gain

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the GDP during this period), this most recent rise may be seen as the market simply getting back on track from the collapse in 2008. While Im inclined to be optimistic about the long term direction of the market (if the period is long enough, who wouldnt b e?), the recent rise since last December is in need of another breather. Observing the pattern from a year ago and its similarity to today, the question is now whether history will repeat itself or, at least, rhyme. I think the answer is most probably yes. Over the last 4 years, I count 5 corrections with durations lasting 2 to 6 months. Another one should not come as a surprise with the only questions being when, how deep, and for how long. Assuming the cause of the correction is mainly technical and not due to the Fed pulling the punch bowl, the depth and length should be livable.

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.)
International equities, represented here by VEU, continue to struggle with 2 (or 3 depending on how you count) attempts to get beyond $47. Multiple failures like this do not generally bode well for near term performance. I do not see international equities in the same positive light as domestic. Where SPY has set record highs going back to 2007,VEU remains nearly 19% below its 2007 high. In fact, while SPY has gained nearly 30% since the beginning of 2011, the broad international index has not gained any net new ground. Whats

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even more telling is that, upon closer inspection of regional exchange-traded funds, the Euro Zone, Latin America, and Asia (including China and India) have not gained ground in over 3 years. Even emerging markets as a whole and Canada are basically where they were over 2 years ago. Observing the chart below and performance over short time periods, a cyclical pattern has emerged that needs to be broken before I would make a substantial commitment to international equities. Therefore, I would look for VEU to break through $49 (or below $42) before moving to neutral, not to mention overweight, in this area. I would also pay close attention to the relative performance as shown on the next page. At present, there is sufficient weakness in the broad index to suggest minimizing international exposure.

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 continue to outperform investment grade corporate bonds, though momentum is precarious and looks overbought. For now, equities have the upper hand, but the relationship deserves close monitoring. On the right, we see that domestic equities are extending their lead over international equities. While there was a bit of weakness in the momentum indicators in February, momentum resumed in March. Based on the current relative strength of domestic equities, I see no compelling reason to go beyond a small allocation to international 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. 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 that the technical dire ction of LQD has turned moderately 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 continues in control. But preferred stocks are not the only income-oriented 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) had another strong month and continues to hold the lead compared to the other sectors over the last 12 months. March was another difficult month for European equities (EZU) with worries of contagion from the Cyprus banking crisis and general weakness across Euroland. With known headwinds, Europe has done remarkably well over the last 12 months though it is faltering in 2013. Gold (GLD) continues to disappoint gold bugs as it barely eeked out a positive result for March. While I realize some others feel differently, I believe gold is better suited for trading than for long term investment or hedging purposes. Oil (DBO) recovered a bit in March, but is still underwater (no pun intended) for the running 12 month review. Emerging Markets (EEM) continued to weaken in March and are now essentially flat for the last 12 months. Investment grade corporate bonds (LQD) have essentially flat-lined for the last 6 months with no demonstrated tendency for the next move.

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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.