July 12, 2016

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

Market Recap for June and Early July

increase until at least December as a number of analysts said, then

Equities meandered for the first three weeks or so of June until the re-

Im having trouble, I admit, reconciling that with the reaction fol-

sults of the BREXIT vote for the U.K. to withdraw from the European

lowing the June payroll report that, if anything, could be seen as giv-

Union became known. With the leave side unexpectedly winning,

ing the Fed license to increase rates earlier.

the S&P 500 immediately tumbled almost 6%. Then, surprisingly, the

Meanwhile, as U.S. equities achieved new highs, international equi-

index not only fully recovered over the next 3 days, but went on to set

ties fared less well. This may not be all that surprising given global

a new all-time record on June 11 as the increase in U.S. non-farm pay-

economic challenges, but still leaves me a bit curious about the

rolls greatly exceeded expectations (recall that May payrolls fell well

strength of U.S. equities given the significance of implicit interna-

below expectations and the 2 months combined still reflect a slowing

tional exposure in the S&P 500.

trend).

The other remarkable event for June was the 10-year U.S.Treasury

If the initial recovery following the selloff after the BREXIT vote was a

yield falling to an all-time low. As a consequence, investment grade

reflection of expectation that the Fed would forestall a Fed funds rate

corporate bonds achieved new highs for the year, with gains far surpassing their distribution
yield, and raising concerns about a new bond
bubble.
With political and economic uncertainty on the
rise, gold has had a spectacular year, more than
making up for its shortfall
last year but still well
short of its high in 2011.
***

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 ag e m e n t
Stock Market Commentary

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FOCUS
This is the first of an occasional commentary on a current economic
issue that I feel could be a potential game changer for worldwide securities markets and economies. I hope you find this information both
interesting and stimulative and encourage you to let me where you
agree or not, and why.
This first FOCUS is on global debt. First, a few facts, then some analysis. According to Bloomberg, The world has continued to borrow

According to Mauldin Economics, at year-end (2015) the ratio of

hand over fist since the financial crisis, adding nearly $60 trillion since

total public and private debt relative to GDP stood at 350%, 370%,

2007 in the process of pushing the worldwide debt load to $200 trillion,

457% and 615%, for China, the United States, the Eurocurrency

or nearly three times the size of the entire global economy. And that

zone, and Japan, respectively. Moreover, 40% of world government

figure takes us only to 2014.

debt is priced at a negative yield (at this writing, 10-year govern-

McKinsey offers these charts (as of the end of 2014):

ment bonds are yielding -0.14% for Germany, -0.24% for Japan, 0.39% for the Euro area, and -0.58% for Switzerland). The interest
rate on the U.S. 10-year Treasury benchmark bond has fallen to
1.37%, an all-time low!
The rise in corporate debt is another concern, especially as so much
of it is being used for stock buybacks. According to the Wall Street
Journal, nonfinancial corporate debt rose $1.4 trillion to $8 trillion
in the 3 years ending in Q3/2015. During the same period, companies bought back $1.3 trillion in shares.
Whats the problem with stock buybacks, you say? After all, resulting shareholders achieve a boost in EPS and share price. The problem is longer term. By using new debt for buybacks, there are two

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

implications:

Page 3

Before going on, let me say that, despite the unprecedented and
growing global debt burden, we do not seem to be at the stage to-

First, when borrowed funds are spent on buybacks rather than pro-

day where recession or a market meltdown is imminent. But that

ductive investment, future earnings, growth and job creation are

doesnt mean that risks arent rising. Consider the following:

impaired as productive capacity is not built.

Record low interest rates harm pension funds and insurance

Second, as debt is being serviced and eventually repaid, funds that

companies. The longer they continue, the greater the risk that

might otherwise be used for organic revenue generation are unavail-

these institutions will fail to meet their liabilities.

able.

Record low interest rates will eventually turn higher. When they

Chinese debt is especially worrisome. According to McKinsey, not only

do, governments will be more hard pressed to make the kind of

has their debt grown to over 280% of GDP, their debt servicing, accord-

infrastructure investments that are needed, not to mention

ing to Mauldin Economics, exceeds 30% of GDP. Over a third of the

meeting current obligations for various transfer payments (e.g.,

growth in global debt since 2007 has been attributable to China, driven

Social Security and Medicare), businesses will begin to cut back

largely by property developers. Nonfinancial corporate debt is now

on investments, and individuals will be less inclined to take out

twice the percentage of GDP as in the U.S. Nearly half Chinas debt is

mortgages, impacting the housing market and related industries.

linked to the real estate sector.

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

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As China addresses its growing debt and overbuilt real estate, just as

Another step is to lighten the exposure to government bonds and

its construction-fueled, debt-supported growth was a boost to global

other beneficiaries of falling interest rates. If theres a bubble in the

GDP, the ripple effect of retrenchment will be felt around the world.

making, corporate and long term government bonds would be a

good candidates.

How will countries address their debt burden? The best choice, of
course, is to grow GDP faster than the debt and faster than rising in-

Some say having an exposure to gold as a hedge to a declining value

terest rates. While this is the most desirable outcome, it may also be

of the dollar is a good idea. Personally, Im not a fan of gold, but I

the least likely.

can understand this point of view. My thought, however, is that of all

the major currencies in the world, the one I worry about least is the

Countries may also renege on debts through restructuring. While this

U.S. dollar. Gold has had a very strong run so far in 2016 with an in-

doesnt sound too attractive, its hardly unheard of take the potential

crease of over 25%, but still trails the S&P 500 on a multi-year basis.

situation in Puerto Rico as an example, or Argentina or Iceland.

The story of global debt and its implications is far more complex
Finally, countries who also happen to have their own currencies can

than I can offer here. The purpose of this FOCUS is help investors

monetize their debt by printing money, thereby deflating their cur-

become aware of the threat from the global debt crisis and how it is

rency. While this can be a dangerous path to take on account of po-

addressed in the future will have an important effect on securities

tential runaway inflation, on a controlled basis, monetization could

markets around the world.

turn out to be the best of poor choices.

How can investors protect themselves in the event of a disruptive debt
crisis? Here are three ideas:
First of all, investors need to remain aware of the circumstances that
can result in market disruption and be prepared to take action. If todays debt burden today becomes a crisis tomorrow, the market could
take a long time to recover.

L a n e A s s e t M a n ag e m e n t

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S&P 500 Total Return

Last month, I cautioned against expanding equity exposure on account of weakening momentum. June
turned out to be a hectic month in the market as the results of the BREXIT vote for the U.K. to withdraw
from the European Union shocked most analysts resulting in a rapid descent of the equity markets. I think
what turned out to be a more unexpected shock was a recovery that was just as rapid as the initial descent,
the reported causes of which varied from an expectation that BREXIT would impact U.S. equities less than
expected to the potential for BREXIT to be reversed somehow to the implication that the Fed would be now holding off a Fed funds rate increase until at least December, if not longer. Then, as the index approached resistance at $210 once more, last Fridays jobs report was met with
an enthusiastic response that took the index convincingly above $210 to a new all-time high for the S&P 500 total return index (the commonly
referred to index, unadjusted for dividends, had a slightly higher close in May 2015). This positive reaction was a bit puzzling since, if anything, it
made it easier for the Fed to put another rate hike on the table in 2016.
Technically speaking, Im still a bit cautious despite upward trend since we still have a slightly worsening momentum and second quarter
earnings reports are due out soon. If SPY holds above the $210 resistance as earnings reports come out, that would be a good sign for the balance of the year.

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 ag e m e n t

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S&P 500 The Longer Term View

Below is an updated 20-year weekly chart of the total return for the S&P 500 with a 60-week moving average trend
line and the momentum indicator MACD. The picture here is brighter than it was at the beginning of the year as
the long term trend channel continues to hold. As said last month, with recovery in the price trend and the beginnings of an improvement in price momentum (MACD), the longer term outlook for the S&P 500 has to be called
cautiously positive. Of some interest, if not concern, is the picture of recent months shown in the insert. Here we see price closing in on the
bottom of the channel. The ideal outcome, of course, is for price to remain in the channel. For that to happen, extra pressure is put on continuation of rising trend in SPY price. With second quarter earnings coming out soon, this will be an interesting development to watch. If price
fails to remain in the current channel, we could have the beginnings of a lower trajectory for U.S. equities. On the
other hand, if price does remain in the channel, it will be confirmation of long term trend begun over 7 years ago.

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 ag e 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,
struggled during June as the BREXIT vote went against expectations and leaves the economic prospects
for Europe and the world in a little more doubt. To the extent one wants to give credence to developing
trend and momentum analysis (admitting that past performance does not guarantee future results), the
picture last month gave a hint that the outlook would continue to weaken. Not shown, but charts for
major subgroup funds, like VEA for developed markets and EEM for emerging markets, all show the same technical weakness as the broader
based VEU. On the basis of the technical outlook alone, Im not finding a particularly compelling reason to encourage a region-specific allocation at the present time.
Add to the technical outlook, recent statements from the OECD Chief Economist and Chinas commerce minister paint a downcast picture for
global economic growth absent aggressive and constructive policymaking. All the more reason to remain cautious about international investing at the present time though to be on the lookout for a potential entry point should markets overreact on the downside.

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 11/30/14,VEU was allocated as follows:
approximately 19% Emerging Markets, 46% Europe, 28% Pacific and about 7% Canada. Past performance is no guarantee of future results.

L a n e A s s e t M a n ag e 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 relative strength of U.S. equities over international equities resumed during June as BREXIT and other challenges to the global
economic picture moved investors away from international equities. This is actually a trend begun in May 2015 with a brief interruption last
April. The divergence between trend and momentum (MACD) from January through May that gave some technical potential to international
equities has now begun to move in sync, thereby giving the relative positive outlook for domestic equities more credence. With the subdued
global outlook mentioned on the previous page, this pattern seems likely to persist for a period of time.

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 ag e 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, 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 chart on the right
also shows a persistent pattern of a strongly negative correlation with the 10-year Treasury yield over
the last 3 1/2 years though its important to note that this relationship gives way from time to time.
Note also that when the Treasury rate remains range bound, LQD also remains range bound.
The key question here is, what does the future hold for interest rates. The 10-year Treasury yield reached an all-time low this past week as concerns over weakness in global growth, BREXIT fallout and negative interest rates in Europe and Japan made U.S.Treasuries the go-to safe sovereign bond. From this point forward, it seems the downside risk for interest rates would be limited, yet we are in unchartered territory. My suspicion, and its just that, is that Treasuries and investment grade corporate bonds will begin to stabilize here despite the strong trend underway.
I believe theres also a risk for a sharp reversal if traders believe a bubble is about to burst. One thing I am more 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 ag e m e n t

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Asset Allocation and Relative Performance

Following weakness last month with the surprising BREXIT vote of the U.K. to leave the European Union, the S&P 500 appears
technically on the verge of losing momentum and outperformance to investment grade (IG) corporate bonds. Keep in mind, however, as discussed on the prior page, that weve experienced an unusually spike in the value of corporate bonds and that is surely
reflected in the worsening picture for equities relative to bonds.
On a longer term basis, perhaps even sooner as the spike in bonds subsides, I expect the weakened picture for equities will reverse to the upside.
However, with uncertainty in the global economic (and political) picture, its difficult to estimate how long the current trend will remain.

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 ag e 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 dropped precipitously in January and again last month, something I think few people, including
me, expected at the beginning of the year. The 10-year yield reached an all-time low at 1.37%.
Meanwhile, the U.S. 10-year rate has been anchored by the major global government bond rates with the current 10-year rate for the U.K. at
0.74% (down from 1.35% last month), Germany at 019% (down from 0.14%) , and Japan at 0.29% (down from 0.1%). Can the U.S. rate fall below zero? Negative rates, or even rates close to zero, have disastrous effects on the economy on fixed income investors and on institutions
with long term liabilities, like insurance companies and pension plans. While its not inconceivable U.S. rates will turn negative, I am not expecting that to happen as long as the U.S. economy continues to grow, even if slowly.

Page 12

L a ne As s e t Ma n age 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.

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

Kingston, NY
Reprints and quotations are encouraged with attribution.