| Model Portfolios: | March | Y-T-D | 12 Mos. | 3 Years | 7 Years |
| Performance Xtender | 1.9 % | 6.2 % | 14.4 % | 71.8 % | 328.9 % |
| Max Xtender | 4.8 % | 11.7 % | 15.7 % | 118.9 % | 735.8 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | 1.1 % | 3.7 % | 10.4 % | 53.1 % | 10.9 % |
Performance Analysis
Models Outperform Market in First Quarter
Our model portfolios nicely out-performed the S&P 500 Index during the first 3 months of the year. The Performance Xtender model beat the market by 67% during the period and our more speculative Max Xtender model gained 11.7% in the quarter compared with only a 3.7% gain by the market.
During the month of March, the market managed to keep the bull market trend alive with a 1.1% gain. But our models have been reading increasing signs of risk in the market and have taken initial steps to shift portfolio allocations into a more defensive posture. Nevertheless, the models still managed to significantly out-perform the market during March.
Three Year Performance Graph (As of March 31, 2006)
In the Performance Xtender model : This model is our most sophisticated strategy for growth investors who have a moderate risk tolerance. The model gained 1.9% during March compared with just 1.1% by a Buy and Hold investor holding an S&P 500 index fund. Over the past 12-month period, this model has returned 14.4% compared with 10.4% by a Buy and Hold investor. Looking at the past 3-year period, which has encompassed most of the recent bull market, the model has accumulated a total return of 71.8% compared with only a 53.1% gain for Buy and Hold. Looking at a longer, 7-year period that incorporated a severe bear market, the model gained a total return of 328.9% compared with a Buy and Hold investor who would have barely done better than break-even with a total return over the 7 years of only 10.9%.
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 jumped 4.8% in March compared with the market's 1.1% increase. Over the past 12-month period, the model has gained 15.7% compared to only a 10.4% gain by the S&P 500 Index. Over the past three years, the model produced a cumulative total return of 118.9% over this bull market period -- 2.2-times more than what the market produced. Looking at the past 7-year period, this model has generated a cumulative total return of 735.8% compared with the market which has done little better than break-even with a total return of only 10.9%.
Market Commentary
A Bear Market Just Around the Corner?
We have frequently discussed in recent months the deteriorating trends we are seeing in the stock market's technical statistics that gauge the health of the balance between the supply and demand for stocks. We have pointed out that this deterioration is typical of the waning phases of a bull market and that the bull's advanced age suggests we may be close to a top. Even though the market managed a grudging 1.1% increase during March, our indicators continue to deteriorate. Overall market volume continues to be weak, showing that large institutional investors are sitting on their hands; and an increasing percentage of individual stocks have already rolled over and appear to have headed into their own bear markets.
There are other corroborating signs of danger ... for example, there has recently been a huge jump in insider sales of stock -- a sign that senior executives are bailing on their own stocks. And, speculation in stocks by the proverbial "little guy" has returned. Discount brokers are reporting fabulous increases in volume. This has always been a contrary sign because the little guy is typically the "last one in".
The economy seems to be rolling along and corporate profits continue to be strong. But beneath the surface, there are a number of disturbing trends that are concerning many investors. Of course, there is the rising cost of energy and we now have crude oil approaching $70/barrel again. There is the decline of sources to support rising consumer spending as the level of interest rates can no longer support mortgage refinancing for the purposes of cashing out. And corporate profits aren't really what they seem to be since the rising profits of energy companies may now account for more than 50% of the total rise in corporate profits. Gold and silver continue to streak to new highs, indicating that inflation expectations are rising with the steady increase in commodities prices generally.
And then there is the recent, upward trend in interest rates.
In the balance of this commentary, we would like to focus on interest rates and their potential contribution to the array of negative factors that could push us toward a new Bear Market. Then, we will address the question of how far the market could fall if we do indeed tip into a Bear Market.
A Chart of 10-Year Treasury Note Yields
(As of March 31, 2006)
The Bond Market is at a Crossroads: In early March, the yield on the 10-Year Treasury Note pushed above 4.66%, and broke out of a trading range that had contained long-term interest rates since mid-2003. By the end of the month, the yield had moved right up to 4.87% which defines the next level of technical resistance.
The reason this is so significant is because this is a level that will define whether interest rates are considered still to be in the long-term downtrend that has been in place since early-2000 ... or alternatively whether interest rates will be seen to be in a new, rising long-term trend. We are right now at the balance point. So, we will be watching closely. If yields break above 4.87%, traders will likely push them up to the next resistance level at 5.47% ... and then potentially even higher. The view in the market will be that interest rates are headed up. And this may be the last nail in the coffin for the aging bull market.
How Far Could the Market Fall? We have been asked whether history provides any clues about how bad the next Bear Market could be. In fact there is. The "history" in this case is what a study of market behavior says about the typical magnitude of corrections. We can apply this history to the current Bull Market and draw some conclusions about how far it could drop. But we must first define which Bull Market we are talking about that would undergo a correction.
We could define the Bull Market as simply the rise in prices since early 2003; or we could look at a very long-term chart and realize that the Bull Market that ended in 2000 actually began back in 1974. If the stock market rolls over soon and drops into a new Bear Market, it could possibly be just an additional "down-leg" of the Bear Market that started back in the year 2000. We will look at both definitions in order to get an idea of the possible range of market deterioration we could see in the next Bear Market.
A study of market corrections shows a high statistical frequency of corrections ending after roughly a 50% "retracement" of a previous Bull Market increase or alternatively, roughly a 61.8% decrease of a previous rise. (61.8% happens to be a Fibonacci mathmatical relationship found frequently within nature and, for example, within the "Golden Spiral".) Applying this historical tendency to the more recent Bull Market rise since 2003, a 61.8% retracement of the rise would project a decrease of the S&P 500 Index from roughly 1300 today down to under 1000 ... producing roughly a 27% loss in the stock market index. If we do have a Bear Market starting soon, a 27% decline would probably be a "best case" scenario.
If we consider a typical 50% retracement of the "secular", 26-year Bull Market that began back in 1974, we find that it has already occured. The Bear Market decline from 2000 to early-2003 was almost a perfect 50% retracement of the market's rise from 1974 to 2000. So, if the Bear Market that started in 2000 were to continue, the upcoming down-leg of the overall decline would likely take the market down to a point that retraces 61.8% of the original 26-year Bull Market ... and that point would involve roughly a 51% loss from current levels.
Our analysis so far has produced a potential range for the decline from 27% to 51%. But two additional points could be forecast. We can also project a potential 44% loss based upon a 61.8% retracement of the Bull Market measured from the market's bottom after the Crash of 1987. And we can also get an estimate of a 63% loss based upon a different historical pattern. By looking at the above chart, you can see that the market's rise went "parabolic" around the year 1995. A "blowoff" rally then ensued, consuming an additional 5 years before the peak. A casual look at other markets that have gone parabolic shows that the correction following the blowoff often retraces back to below the point where the market went parabolic. This historical market tendency suggests that the phenomenal Bull Market of the later-1990's could be entirely erased, taking the S&P 500 from around 1300 currently down to around 400.
- If you are shocked by these projections of a potential decline, note that the Nasdaq declined by over 80% during the most recent Bear Market.
Sell Now or Sell Later? If you buy into any of 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.)
... Portfolio as of April 10, 2006 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| LargeCap Stock Fund | 40% | RYZAX | 40% | BLPIX | 40% | SPY |
| Gold Stock Fund | 20% | RYPMX | 15% | PMPIX | 20% | GLD |
| Corporate Bonds, or Money Market |
Money Market Fund: 40%. ProFunds investors should have 45% in Money Market funds. | |||||
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 April 10, 2006 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Lev'd LargeCap Fund | 50% | RYTNX | 50% | ULPIX | 150% | SPY |
| Unlev'd LargeCap | 50% | RYZAX | 50% | BLPIX | - | - |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the SPY position is margined 1.5-to-1. | |||||
