| Model Portfolios: | February | Y-T-D | 12 Mos. | 4 Years | 8 Years |
| Performance Xtender | -0.1 % | 0 % | 5.4 % | 79.3 % | 367.6% |
| Max Xtender | -0.9 % | -2.4 % | 13.4 % | 153.9 % |
1,008.2 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500 Index Fund) | -2.2 % | -0.9 % | 9.8 % | 70.9 % | 27.1 % |
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 traditional "buy and hold" strategy as measured by the S&P 500 Index.
Performance Analysis: Read a detailed explanation of Model Portfolio performance covering the different times frames presented in the Monthly Tracking Report.
Market Commentary: This month we focus on the major reversal down in the markets.
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
Models Hold Up versus Market Decline
The stock market continued to build on its 6-month rally during February but then peaked and took a nasty fall of -3.7% from the top, ending the month down -2.2%. The sharp sell-off was the second example in less than a year of a global "synchronized" meltdown where almost all individual sectors and global markets fell simultaneously, caught up in a worldwide panic. The other occurance during the last year was in May of last year when the S&P 500 index fell over 5% in 8 days.
Our models however held up well in February mainly because of their shift a month ago into Mid Cap stocks. Mid Caps strongly out-performed the other indexes during the month, so much so that they built up a sizable cushion against the drop last week.
Four Year Performance Graph (As of Feb. 28, 2007)
Results in the Performance Xtender model : This model is our most sophisticated strategy for growth investors who have a moderate risk tolerance, having experienced a maximum peak-to-valley temporary reduction in value ("maximum drawdown") of only -8.5% in the past 8 years. [Editor's Note: compare this to a -45.1% maximum loss experienced by a "buy and hold" investor in an S&P 500 index fund].
This model came in at almost breakeven for February versus a 2.2% loss in the S&P 500 index.
Over the longer term, the model has excelled in providing the strongest ratio of return relative to risk. Looking at the past 4 years which encompassed most of the recent bull market, the model accumulated a total return of 79.3% compared with a 70.9% gain for the market. Looking at a longer, 8-year period ... that incorporated a severe bear market ... the model gained a total return of 367.6% compared with a Buy and Hold investor who would have earned a total return of only 27.1% holding an index fund tracking the S&P 500. The reason the difference is so substantial is because of the model's ability to avoid losses ... and even make money ... during the bear market periods while beating the market handily during the bull markets.
- Performance Xtender 8-year Compound Annualized Return: 21.3% per year
Results in the Max Xtender model : This is our riskiest strategy because it uses leverage to magnify returns during both strong bull markets and bear markets. Yet while earning huge, market-beating returns, it has experienced a maximum peak-to-valley temporary reduction in value ("maximum drawdown") of only -31.5% in the past 8 years. [Editor's Note: compare this to a -45.1% maximum loss experienced by a "buy and hold" investor in an S&P 500 index fund earning mediocre returns].
The model lost a little less than 1% in February versus a 2.2% loss in the S&P 500 index. Over the previous 12-month period, the model beat the market 13.4% vs. 9.8%. Over the past four-year bull market period, the model produced a cumulative total return of 153.9% versus 70.9 for the market. Looking at the past 8 years, this model generated a cumulative total return of 1,008.2% compared with the market which did little better than break-even at a total return of only 27.1%. The reason the difference is so substantial is because of the model's ability to avoid losses ... and even make money ... during the bear market periods while substantially out-performing the market during bull market periods.
- Max Xtender 8-year Compound Annualized Return: 35.1% per year
Market Commentary
Market Suffers Major Reversal
Executive Summary: Our models reduced stock market allocations after last week's severe drop in order to moderate addtional portfolio risk. But it is too early for the models to determine quantitatively whether the internal technical condition of the market has yet deteriorated to a point that warrants even more defensive action. That will be determined by market behavior over the next several weeks and perhaps months. While we expect a period of serious correction to follow in the markets, we don't think it is likely that this downturn will evolve into a new bear market cycle until another rally attempt has been made to recover the old highs.
Trading action in February was very strong until a powerful reversal struck at the end of the month, impacting markets worldwide. The sudden downthrust was a "high volatility event" accompanied by record volume -- almost all of it selling. Very few stocks or business sectors escaped the mayhem. What does this tell us about the market?
Our commentary early last year focused on the advancing age of this bull market and the waning chances for it to continue much further. The risk of a new bear market cycle was increased by significant deterioration in many of the technical indicators we follow that gauge the health of the underlying supply/demand condition of the stock market. Then, a serious correction developed last summer that suggested a new bear market might be at hand. But then in June last year we pointed out that chart patterns suggested the markets needed one more "up leg" before the bull market would end.
We got the additional upleg. A powerful rally was launched in August that pushed the market to new highs and beyond. We also saw substantial improvement during the rally in our technical indicators. By Janaury of this year, the market was backed by a very strong undertow, as measured by our indicators, but had also become very overextended -- and we warned: "Based upon a reading of our two favorite 'overbought/oversold' momentum indicators, the stock market has reached an important threshold ... a degree of overextension that like a rubber band has typically caused a recoil."
The long term chart above of the S&P 500 shows a 4-standard deviation envelope around the market's action and plots a common "momentum oscillator" below. The 4-standard deviation bands have worked well historically to pinpoint times when the market is extremely over-extended on a longer term basis. The last time the market was this over-extended was in early 2004 and it triggered a nine-month corrective sequence (see the blue lines).
As you can see on the chart, last week's drop caused a serious break of the recent uptrend (marked by the green line on the long term chart) right up against the upper 4-standard deviation band. It represented a major reversal of investor psychology that will likely take time to repair. A multi-month correction could easily ensue.
But the longer-term uptrend of the market (see the red trend line in the chart above) was not violated by the drop last week. So we cannot say with any certainty yet whether the bull market is over (although it could be). The long-term uptrend line will provide strong technical support in the neighborhood of 1340 on the S&P 500. So as long as the S&P 500 holds above that line, we must still respect the long-term uptrend.
The second chart shows the serious trendbreak of the shorter-term uptrend line (also in red). It signals at the very least a reversal of the intermediate trend to down. And given the market's sharp rise in the past 7 months without a serious correction, we should expect strong potential for an equally sharp correction in the next phase of market action.
How far could the market fall? We expect that importantl technical support will be provided by the 200-day moving average (the blue line on the chart above) at around 1350 on the S&P 500. This is right in the same vicinity as the long-term trend line referenced above.
- Our overall assessment then is that there is additional immediate downside in the market of as much as -4%. The 200-day moving average and long term uptrend line should provide initial support and some kind of positive reversal should follow. Therefore, we would expect the market to stage a new rally at some point and attempt to recover the highs established a week ago.
But given the age of the bull market and apparent change in investor psychology, there could be significant selling into the next rally. It will be important during the next bullish phase (if there is one) to pay close attention to the technical statistics and evaluate the underlying demand/supply for stocks as a gauge of whether investor psychology has taken a more permanent change for the worse, or not.
And going back to our original projection last summer that the market needed "one more upleg" before its overall pattern would suggest an end of the 4-year+ bull market ... we have had that additional upleg and the sharp reversal last week suggests that it is over, or very nearly over. We expect that the market will make one last rally attempt to recover the old highs, but that may well be it.
The Models Stick With the Trend: It is interesting to note that while our market commentary had a decidedly bearish tone over the previous year, our Model Portfolios remained largely bullish throughout ... and we captured the market's appreciation as a result. It illustrates one of the core benefits of following our Model Portfolios -- their ability to follow and stick with the primary underlying trend of the market, uneffected by anyone's bias.
While our models are quantitatively tracking and analyzing a battery of market risk factors, their allocation logic is designed to stick with the trend. Only in extreme instances of perceived high statistical risk do our models trigger a move against the underlying trend.
From your own perspective as an investor, following models such as these can help you reconcile the constantly conflicting views of different market gurus, economists and advisors. The models provide an objective and disciplined method of investing in the face of ongoing uncertainty. The parameters and action triggers built into our models' mechanical logic is based upon statistically-relevant patterns that have proven a high degree of reliability over decades of market history. In a nutshell, the models provide the investor with an "edge" with which to face off against market uncertainty. The timing of the models is not always perfect. However, the mechanical logic recovers quickly from mistakes, cutting losses short ... and letting profits run.
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 Mar. 4, 2007 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Mid Cap Stock Fund | 60% | RYAVX | 60% | MDPIX | 60% | MDY |
| Corporate Bonds, or Money Market |
40% 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 Mar. 4, 2007 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Lev'd Mid Cap Fund | 50% | RYTNX | 50% | UMPIX | 150% | MDY |
| UnLev'd Mid Cap Fund | 50% | RYAVX | 50% | MDPIX | - | - |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the MDY position is margined 1.5 to 1. | |||||
