| Model Portfolios: | January | Y-T-D | 12 Mos. | 6 Years | 9 Years |
| Performance Xtender | -1.8 % | -1.8 % | 2.8 % | 129.9 % | 358.8 % |
| Max Xtender | -7.9 % | -7.9 % | -9.3 % | 211.9% |
706.5 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Balanced Portfolio (60% stocks 40% bonds) | -3.2 % | -3.2 % | -3.2 % | 32.1 % | 36.6 % |
Dear Subscriber,
This issue of the newsletter includes the following:
Monthly Tracking Report: Get an update on the current performance of our Model Portfolios compared with a traditionally balanced buy and hold portfolio consisting of 60% stock funds and 40% bond funds.
Performance Analysis: See a comparison of the Model Portfolios' performance in Bull Market and Bear Market cycles.
Market Commentary: This month we look at the accumulating evidence that a Bear Market may have begun.
Model Portfolio Allocations: Check the most current portfolio allocations for our Model Portfolios. (Note that allocation changes are announced by email in a separate Trade Alert.)
Performance Analysis
People like to say that "a picture is worth a thousand words." Here we offer two pictures to demonstrate the performance of our model portfolios in two distinctly different market environments:
- Bull Market performance since October of 2002
- Bear Market performance from March 2000 to October 2002
Both model portfolios are compared to a traditional "balanced" portfolio allocation of 60% stock funds and 40% bond funds.
Bull Market
Performance Over the Bull Market Cycle:
Both model portfolios have performed as expected over the period. The Performance Xtender has generated a significant increase in gains compared to a Traditional Balanced Portfolio. And the Max Xtender used leverage to generate almost 3 times the performance, although at the expense of significant volatility.
Bear Market
Performance During the Most Recent Bear Market Cycle:
Both model portfolios delivered a substantial increase in value during the Bear Market of 2000 through 2002. By contrast, a "buy and hold" investor ... holding an index fund representing the S&P 500 index ... would have lost about 45% during the 2 1/2 year bear market. An investor with a "traditional balanced portfolio" would have avoided huge losses during the period but still would have suffered a negative return.
The more significant benefit of following these model portfolios can be seen in the longer term ... over periods that are long enough to include two or more market cycles. A 9-year look back period is long enough to include both of the two most recent market cycles. Over this period of time, the cumulative return of the Performance Xtender (based upon a combination of live returns and "backtested" returns from computer simulation) was 358% ... about 10 times the "traditional portfolio" which returned a cumulative gain of only 37% in 9 years. The Max Xtender, which uses leverage aggressively to accentuate gains in both up and down markets, gained about 19 times as much as the traditional portfolio with a cumulative 9-year return of 706%.
- The simple reason behind the models' huge gains over a traditional portfolio is their ability to dynamically shift investment allocations to avoid huge losses and even make gains during bear market cycles. While a traditional portfolio will lose significant value during a bear market, the model portfolios can make money and are able to compound profits from the bear market period on top of profits earned during a bull market. The cumulative benefit of such compounding becomes huge over time after one or more bear market cycles.
While our model portfolios can be more volatile than a traditional portfolio in the short-run, they are much less volatile in the long run because they can avoid the very deep losses suffered by traditional buy-and-hold strategies from which an investor can take years to recover.
Market Commentary
Footprints of a 'Bear'
Executive Summary: Our quantitatively-based portfolio models are momentarily postured according to a "Neutral" reading of stock market risk. A "Neutral" reading means that the models assess the probability of a continued decline in the market to be roughly offset by the probability of a strong rebound in the near term. However, a longer term technical analysis of the market strongly suggests that a Bear Market has begun and that substantial downside risk to stock market valuations still exists.
[Every month we provide a commentary on the market which is based upon a basic charting and technical analysis approach. You will not find us often discussing the types of "fundamental" factors that most market analysts use to make their case. Hopefully, you will find our commentary refreshing and a welcome change of pace from mainstream analysts.]
While the market pundits seem to assume now that the market has bottomed and the correction is over, a "technical analysis" suggests that the long term trend has turned down. In other words, the balance of technical evidence right now says that we are most likely in a Bear Market.
Bear markets are full of "counter-trend" rallies -- periods when stocks climb against the prevailing downward trend. Such rallies are referred to as "head fakes" and "dead cat bounces" because they tend to get investors excited but then flame out quickly as the demand for stocks is overwhelmed by sellers taking advantage of the higher prices.
The key to a long term bear market is an over-riding bearish psychology among investors that conditions them to "sell the rallies" rather than to "buy the dips" (which prevails as the predominant psychology during bull markets).
The Models are Driven by Objective Analysis
The analytic logic behind our model portfolios is based upon an analysis of the underlying supply and demand conditions for stocks in the market. Therefore, they are based upon an objective view of what is going on in the markets and are not affected by emotional concerns or any kind of "Wall Street Bias".
And based upon this objective analysis, the models have just moved back to a 'neutral' setting. They had been on a 'bearish' setting for most of Janauary. But the models moved back to 'neutral' because of the fairly strong volume and positive breadth of demand in the market since the bounce on Jan. 22nd. Based upon historical patterns, the underlying strength of the bounce increased potential for a larger rally.
But sometimes the models trigger changes that are quickly "whipsawed" by market action, particularly during extremely volatile market conditions. And this may be one of those times. The sharp drop in the market Tuesday represented a "failure" of the breakout last week above the critical 1370 "resistance" level on the S&P 500 index. This is a bearish development and may trigger another significant leg down in the market. If the market continues to slide from here, the models will quickly react by reversing the recent signal and move back to a fully 'bearish' stance.
The Technical Evidence for a Bear Market
We cannot totally discount the possibility that the market could find its footings here and launch a new bullish trend, but the balance of technical evidence for a bear market is very strong at this point. Let's review the essential elements of that evidence.
There have been three successive breakdowns in the technical underpinnings of the market's 5-year bull market trend. They are:
- A confirmed breakdown of the 200-day moving average of the S&P 500 index as well as other important market averages.
- A confirmed breakdown and violation of the market's recent intermediate lows set at about 1370 on the S&P 500 in March and August of 2007. This violates for the first time in 5 years the basic rule that bull markets consist of a series of "higher highs" and "higher lows".
- The un-confirmed breakdown of the "long term uptrend line" that had supported the market's advance during the bull market cycle.
The one element missing is full confirmation of the breakdown of the "long term uptrend line" (in green on the chart). In our view, such confirmation will not occur until the market violates the lower support level at about 1270 on the S&P 500 index where the market bottomed on January 22nd.
Potential for a Crash
There has been discussion in the media about the possibility of another 1987-style crash. The fact that it is being discussed may rull out any real possibility of such a large crash. What made the 1987 crash so unusual was the fact that it seemed to materialize out of thin air without anyone expecting it.
However, what gives us some pause in this analysis is the extremely high degree of investor anxiety right now and the potential for some very serious additional shocks occurring that could hammer investor confidence. There are several additional financial disastors "out there" just waiting to happen. It seems that the subprime mortgage crisis was just the first step in the unravelling of a worldwide "credit bubble". The next shoe to drop may be a collapse of the little-understood companies that provide "credit enhancement" and insurance on many bonds. As things continue to unravel, new financial disastors of large proportions may well crop up in various exotic arenas within the global financial system. We emphasize the word exotic because the expanding crisis seems to be located within the shadows of largely unregulated arenas within the financial world, most of which have sprung up rather un-noticed and/or misunderstood.
Investors Struggle to Remain Upbeat
Because of the "high anxiety" right now, investor psychology is certainly fragile. So we are concerned about investors' reaction in the face of new financial disastors and deepening concern about the foundations of the global financial system.
But we don't believe investors have yet transitioned completely to a "bear market psyschology". Hope dies hard. And many investors are loath to give up yet on the bedrock belief that our economy is fundamentally sound and will recover quickly.
Most of Wall Street seems to be occupied right now in an exercise to "buy the bottom" and load up on high quality stocks that are trading now at what seems like magnificent discounts. This is normal behavior particularly during the early stages of a bear market cycle. So it may well take repeated episodes of disappointment for most investors to adopt a "bear market psychology".
Investor Psychology May Transition in the Form of a Trading Range
While we think the potential for a market crash is something we all need to account for right now in our investment strategies, the next significant feature of market action may be a "trading range".
Specifically, we are talking about the zone from about 1270 on the S&P 500 as the "low point" up to about 1370 as the "high point". This zone is marked out on the chart above by two red lines.
The market may trade back and forth between these two levels of technical "resistance" and "support" as investor psychology takes more time to work itself out. We saw this same phenomenon develop after the market suffered a similar breakdown in the Fall of 2000. In that case, investors were not yet willing to accept the existence of a bear market. People were still caught up in the bullish psychology of the 1990's. As a result, the market "hugged" the point of the technical breakdown in a sideways trading pattern and made repeated attempts to break back above it.
But each attempt to breakout "failed" as investors continued to unload stocks and eventually made a full transition to a bear market psychology. From there, the S&P 500 index dropped another 41% before the end of the bear market cycle 2 years later.
Recommended Model Portfolio Allocations
Model Portfolio: 'Performance Xtender'
(A model portfolio that invests selectively in stock market index funds, plus certain market sectors such as Energy, Gold and Real Estate, and in an Inverse Fund ("Bear Fund"), depending on current market trends for each type of investment. The allocation mix is designed to beat the market significantly during both bull and bear markets with only a limited risk of volatility.)
... Portfolio as of February 3, 2008 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| MidCap Stock Fund | 40% | RYAVX | 40% | MDPIX | 40% | MDY |
| Corporate Bonds, or Money Market |
60% Money Market Fund . | |||||
Model Portfolio: 'Max Xtender'
(A model portfolio that invests selectively in stock market index funds and in an Inverse Fund ("Bear Fund"), depending on current market trends for each type of investment. During strong market trends ... either bullish or bearish ... the model uses up to 2-to-1 leverage to magnify returns. The allocation mix is designed to beat the market substantially during both bull and bear markets but with a relatively high risk of volatility.)
... Portfolio as of February 3, 2008 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| MidCap Stock Fund | 100% | RYAVX | 100% | MDPIX | 100% | MDY |
| Corporate Bonds, or Money Market |
. | |||||
