Download - LFM Commentary November 2009
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normal of lowered re-
turns, especially once
the current and tempo-rary impact of the
stimulus payments wear
off.
Meanwhile, Bill Miller of
Legg Mason Capital
Management points out
that back to 1871, there
has never been a 10-
year period of negative
stock performance that
wasnt followed by bet-
ter than average per-
formance for the next
ten years.
The question is, which is
reality? Is there any doubt
why the market is confused?
...to say the least. During
October, there were 22
trading days. On all but
five of them, the high-low
differential on the Dow
Jones Industrials index ex-
ceeded 100 points, or about
1%. On nine days, the
spread was over 150 points.
Thats huge. Despite a high-
low spread for the month of
about 6%, the index ended
the month just about where
it started.
Last month, I offered my
thoughts on what had been
driving the market since
March. But whats driving
the market now? I submit itis some combination of an-
ticipation of a technical cor-
rection/profit taking, reac-
tion to daily news items,
and reality setting in.
On the technical side, the
market has come so far, so
fast, that there is wide-
spread consensus that a
correction is due.
On the daily news side, in
just recent days, weve seen
evidence of a rebounding
economy with the GDP
scoring a 3.5% annualized
gain last quarter (the first
positive showing in a year)
and the next day weekly
unemployment claims
showed virtually no im-
provement, personal dispos-
able income slipped and
personal spending declined.
And the beat goes on.
The last pointreality
setting inis the critical
one, in my opinion. Just this
past week, two noted in-
vestment gurus offered dif-
fering points of view:
Bill Gross of PIMCO
discussed his view of
the fundamental changes
that have occurred in
the worlds economy
that will result in a new
Confusing...
Stock Market Commentary by Ed Lane
November 2009Lane Financia l Management
pecial points of interest:
A confused market
Green shoots continue,
but is this reality?
While momentum indi-
cators are still positive,
technical analysis sends
out warning signals
Investing opportunities
are limited. Caution is
advised.
Inside this issue:
Confusing...to say theeast
1
At-a-Glance 2
Economic Recap 3
Market Recap 4-5
Technical Analysis 6-8
Fund Highlight 9-11
My Bottom Line 12
Disclosures 13
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Page 2 Lane F inancia l Management
Here is a one page summary of my market
commentary:
The Economy
The Great Recession may have techni-
cally ended with a 3.5% gain the GDP
achieved in the third quarter of this year
(although it is reported that almost all of
the gain came from stimulus and other
government spending, and a slowed pace
of inventory reductionhardly the stuff
of sustainable growth);
The Conference Board's Index of LeadingEconomic Indicators suggested pending
economic recovery with a 1.0% Septem-
ber increase that was the sixth consecu-
tive monthly rise;
A weak dollar, especially with regard to
emerging market economies, has bene-
fited the U.S. economy;
Meanwhile, earlier gains in consumer
confidence have flagged with the contin-
ued run-up in unemployment, flattening
of personal disposable income and de-
clines in personal spending;
As less than half the current stimulus
program dollars have been spent so far, I
expect the economy will enjoy artificial
support well into next year with a real
question mark thereafter.
The Market
The US stock market experienced a
roller-coaster ride in October, ending
the month just about where it began;
Emerging market debt and equity, true to
form of being more volatile than markets
of developed economies, suffered even
more during October, especially in the
last week;
Gold and oil/energy were among thevery few areas that did well in October
Momentum indicators would suggest
that the market still has legs, while ove
bought indicators strongly suggest a
pullback is in the cards. It may have ac-
tually started in October and perform-
ance in November will be most interes
ing to watch.
The Current Opportunities
The best longer-term equity opportuni
ties appear to be in emerging econo-
mies, technology, small cap stocks and
global basic materials;
Gold and emerging market debt con-
tinue to be appropriate hedges against
dollar weakness;
Domestic debt securities offer reason-
able returns with low volatility;
The sharp advance since March has
made many, if not most, markets vulne
able to a pullback. Caution and patienc
is advised.
Fund Highlight
This months focus is on the issue ofdollar weakness and several funds are
highlighted as potential hedge;
My Bottom Line
I am concerned about the U.S. economy
and, at least for the moment, cautiously op
timistic about the market.
At-a-Glance
If all economists were
laid end to end, they
would not reach a con-
clusion.
George Bernard
Shaw
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Page 3 Lane F inancia l Management
There was good news:
The Conference Board's Index of Leading
Economic Indicators suggested pending
economic recovery with a 1.0% Septem-ber increase that was the sixth consecu-
tive monthly rise. The 5.7% increase dur-
ing those six months was the strongest
since early-1983 and the index itself was
at the highest level since October 2007;
The GDP advanced 3.5% in the third
quarter;
U.S. durable goods orders recoveredfollowing declines in the prior two
months.
...and some not so good:
While the advance in the GDP was en-
couraging on the surface, virtually all of
the gain came from non-sustainable
sources: stimulus and other government
spending and deceleration of the decline
in inventories;
Earlier gains in consumer confidence
have flagged with the continued run-up in
unemployment. The Conference Board
indicated that consumer confidence dur-
ing October fell 10.7% from September
(still nearly double last winters low);
While continuing dollar weakness adds
to the economic recovery, the longer
this trend continues, the more dangerous
it becomes as an impetus to rising inter-
est rates and inflation.
I could go on with the good news and that
which is less so, but Id rather talk briefly
about my longer term concerns. As a
Keynesian, I see the GDP made up of four
parts:
Consumer spending, which has previ-
ously contributed about 65-70% toGDP, seems unlikely to rebound as
wage growth is stymied and credit is
tight (among other reasons);
Government spending, which has ac-
counted for about 18-20% of GDP, is
likely to continue with stimulus spendin
continuing relatively high into 2011
though starting to decline mid-2010
(absent any new stimulus programs);
Investment spending, about 8-10% of
GDP, will likely be weak except for
technology and other cost-cutting ex-
penditures; and
Net exports, the balance, at about 5%.
Based on my research, I currently accept
the point of view that the domestic sources
of GDP growth may be constrained to un-
der 2%. If this turns out to be true, the im
plications for employment are bleak. And,
that turns out to be true, the political pres-
sure for more stimulus spending, especially
in an election year, will be hard to resist
further exacerbating federal budget deficits
Other than additional government spending
GDP gains will need to come from net ex-ports. As the U.S. is still the worlds larges
manufacturer, a declining dollar will facilitat
exports, not to mention boost reportable
profits by U.S. companies overseas opera-
tions. But there is the rub: how long and a
what pace can the dollar continue to slide,
and how will it end?
Economic Recap
To those critics whoare so pessimisticabout our economy,I say, "Don't be eco-nomic girlie men!"
Arnold Schwar-zenegger
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In the chart below (as of the end of Octo-
ber), we see the year-to-date performance
of several exchange-traded and closed-end
funds representing selected investment ar-
eas of focus.
In June and August, there were relatively
short-lived corrections (profit-taking?) on
the continued advance upward. Another
decline was experienced starting in mid-
October. In the prior two occasions, the
correction, if it was one, was relatively short
-lived. It is impossible to tell now whether
the current correction will continue further
or not, but my belief is that risk remains on
the downside, whether that shows up this
time or later.
High yield corporate bond performance is
interesting. The return here has exceeded
most markets so far in 2009, and with less
volatility. Since this is a result of both actual
yield and price improvement on the bonds
as risk premiums subsided, it would be unre-
alistic to expect this kind of return going for-
ward. Having said that, I do expect some-
what better returns here than domestic equi-
ties for at least the next year (though default
levels will need to be carefully watched).
Market Recap
Page 4 Lane F inancia l Management
I don't make jokes. I just
watch the government
and report the facts.
Will Rogers
A prospectus for the above funds can be obtained through this website:
http://content.sharebuilder.com/MgdCon/Core/QuotesResearch/ETFProspectus/?cobrand=www
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Looking at selected bellwethers in the chart
below (Ive replaced actual indexes with ex-
changed-traded funds that are intended toproduce comparable results), we see the
above average performance of technology
and basic materials. Gold has basically
matched the S&P 500 performance through
October (see the chart on the prior page)
although it has done so with considerably
less volatility. Financials and real estate have
had the strongest advance since March (but
they also had the steepest decline under thecurrent recession).
I must admit some surprise at the perform-
ance of the Consumer Discretionary sector,
though this may be explained by the boost
from the cash-for-clunkers, the credit forfirst-time homebuyers and other stimulus
programs.
Going forward, I would be concerned about
Financials as bank balance sheets are still
stressed, and commercial and residential
loans are not out of the woods yet.
All sectors are showing the same weakness
in October that the broader markets show
on the prior page. It remains to be seen
how the current correction will unfold.
Market Recap (cont.)
Page 5 Lane F inancia l Management
The surest sign that in-telligent life exists else-where in the universe isthat it has never tried to
contact us.
~Bill Watterson
A prospectus for the above funds can be obtained through this website:
http://content.sharebuilder.com/MgdCon/Core/QuotesResearch/ETFProspectus/?cobrand=www
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Quoting from the Journal of Indexes regard-
ing investment in currencies but applicable
to other investments: Fundamental analysis
explains currency movement in terms of
macroeconomic variables such as growth,
inflation, monetary policy, etc. One of the
weaknesses of fundamental analysis is that it
says very little about the timing of moves
and risk management.
Timing is an important part of risk manage-
ment. Even rudimentary technical analysis
can help investors fine-tune their entrance
into an investment and help quantify the
risk. Monitoring the price action itself will
likely reveal a higher probability of success-
ful opportunities.
I agree.
For the purpose of this months Commen-
tary, here is what I see in the chart of the
S&P 500 index on the top of the next page:
A very positive momentum signal as
price has broken through both the 75-
day exponential moving average* (75
EMA) and the 150 EMA
A positive signal as the 75 EMA has
crossed over the 150 EMA while the
150 EMA has an upward slope (although
the 75 EMA may be rolling over anegative sign)
The MACD* accurately showed an ex-
treme oversold situation last November
and again in March. In June, MACD
showed the beginnings of a market re-
versal but has been non-committal
(though slightly trending negative) since
then.
The second chart shows comparable infor-
mation for the MSCI Emerging Markets in-
dex. Notice the even more positive indica-
tions of the EMAs on this chart. On the
other hand, the 950 resistance line is still
intact.
On page 8, I show two charts illustrating the
performance of the S&P 500 index (in black)
compared to the percentage of stocks
within the index that are above their 150
and 200-day moving averages (in red), re-
spectively. Notice how the percentages
have now fallen below 90% in both charts
and, if past is prologue, can be expected to
fall further.
Thats the point we are at today and that is
a cautious signal indicating strong potential
for a correction of indeterminate size andduration (not to mention timing).
* I use an exponential moving average rather
than a simple moving average as the EMA
gives greater weight to recent values. The
MACD (moving average convergence diver-
gence) indicator is another favorite tool of
mine and is used to judge the direction and
momentum of a securitys price.
The selection of the specific indicators and
parameters in the technical analysis used
herein is subjective on my part and is not
intended as a specific recommended analysis
for the S&P 500 or any other investment.
Technical Analysis
Page 6 Lane F inancia l Management
I can't be out of money,
I still have checks left.
Anon.
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Technical Analysis (cont.)
The S&P 500 and the MSCI Emerging Markets indexes are unmanaged indexes which cannot be invested into
directly. Past performance is no guarantee of future results.
Page 7 Lane F inancia l Management
Its not hard to meet
expenses; they are
everywhere.
Anon.
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Technical Analysis (cont.)
The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of
future results.
Page 8 Lane F inancia l Management
Help Wanted: Tele-
path. You know where
to apply.
Anon.
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In this section, I normally highlight an ex-
change-traded (ETF) or closed-end fund
(CEF) that may be appropriate for certain
portfolios. This month, I will focus insteadon a specific investment issue and then tie
that back to specific fund ideas.
The issue I have in mind is U.S. dollar weak-
ness. While domestic inflation is currently
tame, dollar weakness inflates the cost of
imported goods (think oil and other foreign-
supplied commodities, for example) and may
eventually lead to higher domestic inflation.
I believe dollar weakness is in the cards over
the next two or three years (at least), espe-
cially with regard to emerging market cur-
rencies, for the following reasons:
A weak dollar is positive for domestic
employment as exports increase and
outsourcing decreases, thus policymak-
ers will be reluctant to make moves
(such as raising interest rates) thatwould strengthen the dollar;
With as much as half of profits gener-
ated by U.S. companies coming from
abroad, currency weakness leads to
more dollar profits being reported on
U.S. income statements;
A weak dollar draws foreign purchases
of domestic assets such as stocks andreal estate, boosting their value;
Low U.S. interest rates motivate traders
to engage in the carry trade where
they borrow in the U.S. and buy foreign
currencies and invest in foreign debt,
exacerbating currency value differen-
tials;
Emerging markets are recovering from
the global recession faster than devel-
oped economies and, by building do-
mestic demand (relying less on exportsto the U.S.), further strengthen local
currencies vis--vis the dollar.
Here are several funds that illustrate differ-
ent approaches for hedging against dollar
weakness:
State Street Global Advisors SPDR
Gold Shares (symbol: GLD). GLD is
intended to reflect the performance of
gold bullion.
Western Asset Emerging Markets Debt
Fund (ESD). ESD invests in both in-
vestment grade and non-investment
grade emerging market government
bonds with a current emphasis on Rus-
sia, Brazil and Mexico.
Templeton Global Income Fund
(GIM;). GIM also invests in emerging
market government debt, but is more
diversified than ESD and also invests in
the U.S. and other developed markets.
iShares Barclays TIP Bond (TIP). TIP
invests in U.S. inflation-protected Treas-
ury bonds and, therefore, is intended to
Fund Highlight
Page 9 Lane F inancia l Management
I expect to see the stockmarket a good dealhigher than it is todaywithin a few months.
- Pronouncement by
economist Irving Fisher
(1867-1947) in mid-Oct.
1929 as markets began a
-89% rout
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reflect current and anticipated changes
in the CPI.
The PowerShares DB Index Dollar
Bearish Fund (UDN). This fund isdesigned to replicate the performance
of being short the US Dollar against the
following currencies: Euro, Japanese
Yen, British Pound, Canadian Dollar,
Swedish Krona and Swiss Franc (note
that these do not include emerging mar-
ket currencies).
Charts on the next page compare the per-
formance of these funds to a fund repre-
senting the S&P 500 (SPY) over 1- and 3-
year periods. I would note the following:
Over both periods shown, all the dollar
hedging funds outperformed the S&P
500;
Gold and the global/emerging market
income funds outperformed both TIP
and UDN, illustrating that, at least for
the period shown, dollar weakness
against emerging markets was greater
than both domestic and developed mar-
ket inflation; and
Gold and global/emerging market funds
showed much more volatility than the
TIP and UDN over the illustrated peri-
ods.
Please note that these funds have been selected
to represent their respective categories and are
not intended to be a selection of the best
within their category nor a recommendation for
investment.
Note also that that the past performance of
these funds can not be taken as an indication of
future performance. Indeed, the performance
and inherent volatility of these funds may make
them more susceptible to a market
correction. Such a correction may have actu-
ally begun in the last week of October or could
occur at any time. Investing in commodities
(like gold) and unhedged foreign markets should
be undertaken with care as they carry special
risks and typically greater volatility.
Fund Highlight
Page 10 Lane F inancia l Management
Further information about these funds can
be found at:
For ESD: http://www.leggmason.com/
IndividualInvestors/products/closed-end/
product_list.aspx
For GIM: https://
www.franklintempleton.com/retail/jsp_app/
home/ft_home.jsp
For GLD: http://www.statestreetspdrs.com
For SPY: http://statestreetspdrs.com/precise/market_cap#large+40
For TIP: http://us.ishares.com/product_info/
fund/overview/TIP.htm?qt=TIP
For UDN: http://
www.invescopowershares.com/products/
overview.aspx?ticker=UDN
An economist is a man
who states the obvious
in terms of the incom-
prehensible.
Alfred A. Knopf
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Fund Highlight
Page 11 Lane F inancia l Management
People are living in a
pretend-and-extend en-vironment, waiting forthe economy to re-cover. (Referring to the
precarious state of thecommercial real estatemarket and the wave of
resets coming due be-tween 2011 and 2013.)
Robert J. Shiller, Ar-thur M. Okun Professorof Economics, Yale Uni-
versity
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I am concerned about the U.S. economy
and, at least for the moment, cautiously op-
timistic about the market. Heres why:
I believe the domestic economy is morestabilizing than recovering. Following
what appeared to be the end of the world
as we know it a year ago October and again
last January-February, our government and
governments around the world poured tril-
lions of stimulus dollars into our respective
economies.
Focusing on the U.S. economy, stimulus pay-
ments into the states, cash-for-clunkers, first
-time home buyer credits, and extensions of
unemployment benefits seemed to put a
floor under consumer spending and job
losses.
As mentioned earlier, the third quarters
3.5% GDP gain came largely as a result of
stimulus payments and a deceleration in the
pace of inventory liquidation. With stimulus
payments scheduled to peak mid-2010 and
continue into 2011, absent a new stimulus
program or substantial cuts in taxes, roughly
3% of GDP growth could disappear.
The concern Ive expressed for a while is
where will sustainable new jobs come from?
Without jobs (and a relaxation in credit),
consumer spending will remain depressed.
Consumers may see this already. From TheConference Boards recent release on the
decline in consumer confidence:
Consumers' assessment of present-day
conditions has grown less favorable, with
labor market conditions playing a major role
in this grimmer assessment. In fact, the Pre-
sent Situation Index is now at its lowest
reading in 26 years. The short-term outlook
has also grown more negative, as a greater
proportion of consumers anticipate business
and labor market conditions will worsen in
the months ahead. Consumers also remain
quite pessimistic about their future earnings,
a sentiment that will likely constrain spend-
ing during the holidays."
And these are just some of my concerns
about the U.S. economy. The stock market,
on the other hand, is a different story be-
cause:
Technical indicators still show positive
momentum (barely so in some cases),
probably owing to a variety of green
shoots regardless of sustainability or
(lack of) substance behind them;
The stock market is much broader than
the U.S. economy and there are many
opportunities for diversification;
Continuing dollar weakness enhancescertain international markets as well as
reportable profits for U.S. companies
with overseas operations; and
Markets react more quickly than econo-
mies and to factors not directly related
to the economy, such as hordes of cash
seeking higher returns than T-bills and
the daily news cycle.
As these factors can change with very little
notice, caution is emphasized. Investors
should consider raising cash (or moving to
stronger areas) on a measured basis to both
protect against downside risk confronting
equities as well as to improve position when
the next buying opportunity presents itself.
My Bottom Line
Page 12 Lane F inancia l Management
Computers make very
fast, very accurate mis-
takes.
Anon.
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Lane Financial Management is a Registered Investment Adviser with the States of NY, CT
and NJ. Advisory services are only offered to clients or prospective clients where Lane
Financial Management and its representatives are properly licensed or exempted.
No advice may be rendered by Lane Financial Management unless a client service agree-ment is in place.
Stock investing involves risk including loss of principal. Investing in international and
emerging markets may entail additional risks such as currency fluctuation and political in-
stability. 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 ad-
versely 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 Financial 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 risktaken in a portfolio should be commensurate with ones overall risk tolerance and financial
objectives.
Page 13Lane F inancia l Management
In the eyes of public
opinion, the contrarian
investor faces a lose-
lose proposition. When
contrarian approaches
fail to keep pace with
the current market
darling, more-
fashionable players
mock the out-of-step
thinker. When con-
trarian approaches sur-pass the alternatives,
consensus-oriented
players decry the irre-
sponsibility of the un-
conventional inves-
tor.
David Swenson,
Yale University Endow-
ment Fund Portfolio
Manager
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 feedback and
look forward to addressing any questions you may have. You can find me at::
www.LaneFinancialManagement.com
Lane Financial Management
P.O. Box 666
Stone Ridge, NY 12484
917-575-0299
Reprints and quotations are encouraged with attribution.
http://www.lanefinancialmanagement.com/http://www.lanefinancialmanagement.com/mailto:[email protected]:[email protected]:[email protected]://www.lanefinancialmanagement.com/