Stock Market Commentary June 2016

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Market Recap for May

May began on a weak note as U.S. nonfarm payrolls fell below expectations and

lack of productivity growth coupled with wage gains foreshadowed potential

stagflation and weakness in the GDP. The second week was brighter with retail

sales coming in ahead of expectations along with a big rise in consumer senti-

ment. While the prospects for a fed funds rate increase overshadowed the mar-

ket during the first three weeks, those fears subsided as stocks rallied in the final

week on news that new home sales rose at their fastest pace since January 2008.

First quarter GDP was revised to an annualized +0.8% in the second estimate, up

from the initial reading of +0.5%.

May ended on a sour note with the month’s nonfarm payrolls reported on

June 3rd far below expectations, even after taking the Verizon strike into ac-

count. A declining trend has been in place since October 2015. Note, however,

that within minutes of the market absorbing the news with a sharp sell -off, equi-

ties bounced back to a very small loss for the day — probably on account of di-

minished expectations for a June fed funds rate hike.

Managing Expectations

At the beginning of the year, my 2016 forecast was a very modest 3-5%

growth in the S&P 500. While it’s too early to tell how accurate that predic-

tion will turn out to be, there have been a number of recent research notes

that support that theme, two of which are:

McKinsey & Company’s April report (“Why Investors Need to Lower

Their Sights”) points to favorable economic and business fundamentals of

the last 30 years that are unlikely to be repeated. Not the least of these

was an almost monotonically declining rate of interest on benchmark 10-

year Treasury bonds. As a result, according to McKinsey, where U.S. and

European equities and bonds for the last 20 years enjoyed a compound an-

nual growth rate (CAGR) of about 8% and 5%, respectively, their forecast

for the next 20 years is between 4 and 6.5% for equities and 2% for 10-year

Treasury bonds.

In Janus Capital’s June letter, Bill Gross (formerly of Pimco) uses a perspec-

tive similar to McKinsey’s by pointing out that asset returns for the last 40

years have been driven by declining interest rates, trade globalization, and

credit expansion, three areas that have reached or are very close to reach-

ing their limit. Using historical equity risk premiums and an estimate for

bonds similar to McKinsey’s, Gross derives expected projected CAGR for

equities of about 4.5-6% for the next 10 years to which he attaches a

healthy dose of caution on account of distortions introduced by global

monetary and fiscal policies.

No one knows what the future holds in terms of investment returns. But it’s

hard to look back at the drivers of past returns and not conclude that a new

set of drivers will be needed for coming decades. My view is that major infra-

structure spending is needed. Unfortunately, Washington does not yet agree.

2015 Review and 2016 Fearless Forecast June 5, 2016

Lane Asset Management

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 to-

tal 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 opportu-

nity. Prospectuses for these ETFs can be found with an internet search on their symbol. Past performance is no guarantee of future results.


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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.

Page 2Lane Asset Management

It’s hard to tell, but there’s a chance we may be about to experience déjà vu all over again — meaning, to me,

if focus is limited to the technical outlook, there seems to be an increasing amount of downside risk.

As we sit today, the current price pattern for the total return of the S&P 500 (SPY) is looking an awfully lot

like the pattern that played out from August to December of last year. One worrisome indicator is the simi-

larity of the pattern of weakening momentum shown by the red arrows on the MACD at the bottom of the

chart. Another is the price resistance around $210 which has been in place for over a year and tested on numerous occasions (the flip side of

this analysis is that any sustained breakthrough above $210 should be taken as a very positive sign).

On the more optimistic side, we do have an increasing price trend in place and, while corporate profits have been weak, they remain positive;

consumer sentiment is rising; the growth rate in GDP retains a solid, if not spectacular, annualized growth rate of about 2%; and the market

seems to have reconciled itself to an increasing fed funds rate.

S&P 500 Total Return


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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.


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 held in the first quarter of the year. 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 cau-

tiously positive. The main question is whether or not the index can break through the price resistance around $210 in a convincing fashion. For

now, at least, the threat of falling outside the rising price channel has subsided.

S&P 500 — The Longer Term View


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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. 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.


International equities, represented here by Vanguard’s all-world (ex US) exchange-traded fund VEU, fol-

lowed the S&P 500 out of the doldrums at the beginning of the year, breaking through resistance at $41

but stalling around $44.25. With price trend and momentum beginning to weaken, I’m not encouraged

about the prospects for the broad index. In addition, following an examination of exchanged-traded funds

covering different regions of the world, on the basis of the technical outlook alone, I’m not finding a par-

ticularly compelling reason to encourage a region-specific allocation at the present time. One country that does seem to be

bucking the weak trend is India.

Add to that recent IMF forecasts for sluggish global growth, including “severe headwinds” for Asian economies (especially Chi na), I believe the

international exposure of U.S. companies provides adequate global diversification without the added risk of a more focused approach.

All-world (ex U.S.)


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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.


Asset allocation is the mechanism investors use to enhance gains and reduce volatility over the long term. One useful tool I’ve

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 equities faltered in the first half of April but has since resumed with the beginnings of positive trend and

momentum. On a year-to-date basis, as of this writing, SPY has outperformed VEU by over 2 percentage points and has maintained positive

relative performance for virtually the entire year, so far.

Asset Allocation and Relative Performance


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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.


Investment grade corporate bonds, represented below by the exchange-traded fund LQD, experienced

an unexpected spurt in March and April for reasons that are not entirely clear to me. First, as shown be-

low, the correlation between investment grade bonds and interest rates departed a long-running pattern

of negative correlation. At the same time, the correlation between bonds and equities (not shown)

swung into high gear with a well-above-average positive correlation.

The one thing I can point to for the rapid increase in LQD is the spurt in bond fund inflows that followed net outflows in 2016 prior to March, as

reported by Market Realist and Lipper. What I can’t say is the degree to which this was a result of increased investor caution or a reach for

yield.

Income Investing


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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.


Following weakness in the first 45 days of the year, the S&P recovered its outperformance of investment grade (IG) corporate

bonds quickly in the subsequent 15 days and is showing rough balance for the last 3 months. My view is that, while I don’t expect

great things out of equities, I have even lower expectations — at least on a relative basis — for IG bonds on account of the ex-

pected gradual rise in the fed funds rate and the benchmark 10-year Treasury bond rate.

On a longer term horizon, I expect the relative balance shown in the current pattern will be broken to the upside in favor of equities, but that

the degree of outperformance will be more in line with the approximate 3.5% annualized excess return for the period between 2014 and 2016, if

not lower, rather than for the period before 2014.

Asset Allocation and Relative Performance


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PFF seeks to track the investment results of the S&P U.S. Preferred Stock Index (TM) which measures the performance of a select group of preferred stocks . 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.


In this chart, we have the relative performance of the S&P U.S. Preferred Stock Index ETF (PFF) to invest-

ment grade corporate bonds showing relative strength of preferred stocks.

While investment grade corporate bonds have generally been inversely related to the 10-year Treasury yield,

the same has not been true for preferred stocks, especially those of financial institutions or REITs. In fact, asshown below, there is a generally positive correlation between the yield on the 10-year Treasury bond and the

relative performance of preferred stocks to investment grade corporate bonds. With the expectation of a slowly rising 10-year

Treasury yield (despite recent experience) and the improving trend and momentum of the relative performance with bonds, I believe preferred

stocks offer an excellent alternative income-oriented investment.

Income Investing


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Shown 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 market’s 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, something I think few people, including me, expected at the

beginning of the year. Thereafter, the 2-year rate has been volatile as the expectations for a fed funds rate increase have wavered along with the

monthly employment reports. Most recently, while the market seemed to have accepted the likelihood of a rate increase in June, that view fell

away with the weak May employment report.

Meanwhile, the 10-year rate has been anchored by the major global government bond rates with the current 10-year rate for the U.K. at 1.35%,

Germany 0.14%, and Japan – 0.1%. U.S. Treasuries continue to be seen as the safest bet among major country government bonds.

Interest Rates


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Edward Lane is a CERTIFIED FINANCIAL PLANNER™. Lane Asset Manage-

ment 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 li-

censed or exempted. No advice may be rendered by Lane Asset Man-

agement unless a client servi ce agreement is in place.

Investing involves risk including loss of principal. Investing in interna-

tional 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 es-

tablished 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 trans-

action 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 one’s overall risk tolerance and financial objectives.

The charts and comments are only the author’s view of market activity

and aren’t recommendations to buy or sell any security. Market sectors

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Disclosures

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 feed-

back and look forward to addressing any questions you may have. You can find me at:www.LaneAssetManagement.com

[email protected]

Edward Lane, CFP ®

Lane Asset Management

Kingston, NY

Reprints and quotations are encouraged with attribution.

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 aren’t predictive of any future

market action rather they only demonstrate the author’s opinion as to a range of pos-

sibilities 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-

tained herein or any decision made or action taken by you or any third party in reli-

ance 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 ex-

pressed 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 ob-

jectives and financial position. The price or value of the investments to which this re-

port relates, either directly or indirectly, may fall or rise against the interest of inves-

tors. 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.
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Stock Market Commentary June 2016