| Model Portfolios: | February | Y-T-D | 12 Mos. | 3 Years | 7 Years |
| Performance Xtender | -4.6 % | 4.3 % | 7.5 % | 70.1 % | 343.6 % |
| Max Xtender | -1.0 % | 6.6 % | 3.5 % | 124.0 % | 877.6 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | 0.1 % | 2.6 % | 5.0 % | 55.5 % | 13.7 % |
Performance Analysis
Bull Struggles to Advance in February
During February, the market traded down, then up and then down again to end the period with no net gain. Stocks have moved sideways within a narrow trading range, struggling to hold onto the significant break-out staged by the market in January. For now, the bull market trend remains intact and stocks are working through an intermediate, sideways correction. But the mature bull market is clearly aging and struggling to establish each new high. Making forward progress is increasingly difficult.
Three Year Performance Graph (As of February 29, 2005)
In the Performance Xtender model : This model is our most sophisticated strategy for growth investors who have a moderate risk tolerance. Its ability to invest in select sector investments from time to time has helped it to nearly double the performance of a simple Buy and Hold strategy so far this year. However, it lost 4.6% during February due to significant volatility in its Gold and Energy stock investments (the Gold stock position was sold later in the month locking in a 28% gain on the investment). While this model remains aggressively postured, its logic may soon become more defensive because of recent deterioration in certain factors underlying the market's technical health.
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. It lost 1% during February as the market gyrated in a sideways pattern. While this model remains aggressively postured, its logic may soon become more defensive because of recent deterioration in certain factors underlying the market's technical health.
Market Commentary
Charging SmallCaps ... A Sign of Market Strength?
Since November of last year we have had a focus on the steadily deteriorating condition of the supply and demand factors that underlay the health of the stock market. We pointed out that these factors have historically shown a pattern of deterioration for months before a bull market in stocks finally ends.
It has now been almost 6 months since the signs began and the deterioration continues. However, from a technical perspective, the bullish price trend in the major stock market averages (except perhaps the Nasdaq) remains intact and the logic behind our Model Portfolios respects that. So, with the exception of the very risk-averse Conservative Portfolio model, our investment models remain bullishly postured.
Where do we see deterioration in the market's health? One clear example is in the "breadth of participation" by different sectors and individual stocks within the broad market. We have seen a steady drop off in the number of sectors and stocks that are continuing to make new highs along with the market averages. More and more stocks are dropping away and rolling over into bearish patterns. The percentage of companies that remain in bullish uptrends is dropping. This is clear evidence of waning demand for stocks generally as investors migrate into fewer and fewer individual names that continue to perform.
The patterns of trading volume not only show a picture of waning total demand for stocks but also the tell-tale signiture of "distribution" which typically occurs before significant market peaks. This is a pattern that indicates that the smart money is selling. In addition, there are numerous other technical market factors that are showing historically familiar patterns of deterioration typically seen during the months leading up to a final peak in a bull market.
SmallCap Stocks Continue to Lead: Contrary to the picture of deteriorating health, many analysts (including ourselves) have pointed to the continuing strength in SmallCap stocks as a positive indication that all is well in the market. This seems to be true because investors have historically moved away from the riskier SmallCap segment and favored LargeCaps prior to the end of bull markets ... which is all part of the "flight to quality" typically seen toward the end.
A Chart of SmallCap Stocks Compared With LargeCap Stocks
- Therefore, the mere fact that SmallCap stocks have continued to out-perform LargeCaps, as seen in the chart above, provides fuel for the belief that this bull market has a long way to go.
However, the interesting exception to this rule was the major market top back in 2000 when the technology stock bubble burst and the bear market began. The chart below of the 8 months leading up to the March, 2000 peak shows that SmallCap stocks continued to lead LargeCaps right up until the end.
Perhaps even more interesting is the fact that SmallCap stocks continued to out-perform LargeCaps even after the bubble burst. As you can see in the chart below tracking the comparison for 10 months after the top, SmallCap stocks never experienced the same degree of deterioration although they were highly volatile.
It leads us to wonder whether the nature of our economy has changed such that investors increasingly perceive SmallCap stocks as higher quality investments than LargeCap stocks. Or, perhaps the phenomenon back in 2000 was simply driven by the extraordinary degree of speculation existing during that bull market ... a one-time phenomenon unlikely to be repeated.
On Balance, the Signs Point to a Renewal of the Bear Market Cycle: The analysis of SmallCap performance at the previous market top in 2000 suggests that their current pattern of strength shouldn't lead us necessarily to conclude that the market's health is fine. On balance, a broad range of indicators still point to a significantly weakening condition if not an outright end to the bull market.
Sell Now or Sell Later? If you buy into this analysis, then the natural question is whether you should sell out of your stock portfolio now or later. But please understand that by following any of our Model Portfolios, you no longer need to ask such a question. The models are designed to follow the market's action closely ... so you don't have to. So, as long as this bull market remains intact, the models will maintain a significant exposure to the stock market and participate in the continued price appreciation. But when the bullish trend ends, the models will reduce, and then fully exit, their stock market exposure in order to lock in the profits from the past three years. And the models will posture themselves to take advantage of the bear market and make some money.
If the analysis offered above turns out to be wrong and the stock market evolves into another mega-bull experience similar to the 1990's, you will be no worse off by following one of our models. Again, the reason is simple: Our models follow the market's trends. They let the market do the talking. You needn't worry about anyone's fundamental analysis of the economy or the market, because the model will simply follow the market and make sure you participate in the upside and avoid most of the downside.
What could be simpler than that?
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.)
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| MidCap Stock Fund | 40% | RYAVX | 40% | MDPIX | 40% | MDY |
| SmallCap Stock Fund | 40% | RYAZX | 40% | SLPIX | 40% | IWM |
| Energy Stock Fund | 20% | RYEIX | 15% | ENPIX | 20% | XLE |
| Corporate Bonds, or Money Market |
Money Market Fund: 5% if using ProFunds. | |||||
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.)
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Lev'd SmallCap Fund | 50% | RYTNX | 50% | UAPIX | 100% | IWM |
| Unlev'd MidCap Fund | 50% | RYAVX | 50% | MDPIX | 50% | MDY |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the MDY position is un-margined and IWM is margined 2-to-1. Rydex Investors: Note that Rydex does not have a leveraged SmallCap fund so we have substituted RYTNX. | |||||
