| Model Portfolios: | May | Y-T-D | 12 Mos. | 3 Years | 7 Years |
| Performance Xtender | -3.8 % | 4.2 % | 12.6 % | 50.1 % | 300.9 % |
| Max Xtender | -4.9 % | 6.1 % | 10.0 % | 60.2 % | 722.9 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | -3.1 % | 1.7 % | 5.9 % | 34.5 % | 7.2 % |
Performance Analysis
Market Reversal in May
After setting a new 52-week high early in the month, the market reversed hard and dropped on heavy selling across most sectors. By the end of the month, the S&P 500 index had dropped 3.1% while the more volatile Russell 2000 small-cap index dropped 7.1%.
Both of our Model Portfolios somewhat underperformed the market in May. But year-to-date, both models have nicely outperformed. And over longer periods such as 12-months, 3 years and 7 years, the models have significantly outperformed.
Three Year Performance Graph (As of May 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 lost 3.8% in May compared with a 3.1% loss for a hypothetical Buy and Hold investor holding an S&P 500 index fund. Because of this model's periodic exposure to several sector funds, its performance can be somewhat more volatile than the broad market averages during short-term market swings. However, its track record has shown it to be much less volatile over longer time periods and the model has delivered the strongest risk-adjusted return of any of our Model Portfolios. The model's volatility in May was occasioned by the sharp drop in Gold from its recent highs which affected the model's current investment in Gold stock funds.
Over the past 12-month period, this model has returned 12.6%, beating the 5.9% earned by a Buy and Hold investor. Looking at the past 3-year period, which has encompassed most of the recent bull market, the model accumulated a total return of 50.1% compared with only a 34.5% 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 300.9% compared with a Buy and Hold investor who would have had a total return over the 7 years of only 7.2%. 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 7-year Compound Annualized Return: 21.9% per year
This model is currently defensively postured with only a 40% allocation to the stock market averages and a 20% allocation in cash. In addition, the model has a 20% allocation in each of two "defensive" sectors: Gold and Energy stocks.
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. The model is currently using 1.5-times leverage, so while the S&P 500 index was down 3.1% during May, the model was down 4.9%. However, the model is still up 6.1%% for the year; and over the past 12-month period, the model has gained 10.0% compared to only a 5.9% gain by the S&P 500 Index. Over the past three years, the model produced a cumulative total return of 60.2% over this bull market period -- allmost 2-times what the market produced. Looking at the past 7-year period, this model has generated a cumulative total return of 722.9% compared with the market which has done little better than break-even with a total return of only 7.2%. 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 nearly doubling the performance of the market during the bull market periods.
- Max Xtender 7-year Compound Annualized Return: 35.1% per year
This model remains fairly aggressively postured, with a 150% allocation to the stock market averages (leveraged 1.5 to 1). This model is designed to "swing for the fences"; but because of the heightened market risk discussed earlier, the model has ratcheted back both total market exposure and its volatility setting to reduce the potential impact of any market decline.
Market Commentary
Has the Bull Market Top Been Seen?
Since late last fall we have discussed the deteriorating trend in the underlying statistics that measure the market's technical condition -- the underlying supply vs demand for stocks. The deterioration in many of these statistics has become acute and we have been expecting some kind of market reversal to occur.
In May we got that reversal. Now the question is What Does It Mean? Is this just a minor correction? Or has the Bear Market begun?
The long period of market deterioration that we have already seen suggests that the peak in May is a strong candidate for a market top ... meaning that the Bear Market could have already begun. But we are not convinced of this mainly because of the chart patterns currently found in the Dow, the S&P 500 index and the small-cap Russell 2000 index. The patterns are all suggestive of one more new high needed before a final top can be seen. Incidentally, the Nasdaq 100 index does not exhibit this same pattern and is showing signs that its peak in January may have been its final high.
Is the Market Ready to Bounce?
Ready for a Bounce : The chart above shows where the market closed the month of May. The sharp drop stalled right at the important Long-Term Support Line (in red) we highlighted in last month's commentary. The important 200-day Moving Average (in dark blue) is also supporting the market at about the same level.
The market has also become "oversold" on a momentum basis as shown by the Stochastic Oscillator shown on the chart. The liklihood of some kind of bounce from this level is very high.
Keep an Eye on Technical Support Levels: For us to believe that the Bear Market may have begun, we will need to see a convincing break-down of the S&P 500 beneath the 1245 support level, the 200-day moving average and also the key uptrend line (in light blue) that has defined the latter stages of this Bull Market. Such a significant break-down would be an important first step for the stock market before it can evolve into a bear market psychology.
- If the market breaks down below these levels and then rallies strongly back above them ... the market will have created an important "false break-down" pattern that should signal the onset of a new upward phase of this Bull Market that could last for several months at least.
So the current zone of support between about 1230 and 1245 on the S&P 500 index is key. If the market can successfully test the zone and rally back, it should signal a continuation of the Bull. Conversely, if the market breaks down through this zone and fails to recover strongly above it, we would expect at the very least a much deeper correction ... if not a beginning of a new Bear.
Buy or Sell? This may turn out to be a good entry point for new purchases of stocks. But we should emphasize that the risks are increasing. We may only see a minor bounce before the market breaks down further. And if the market recovers strongly here within the next several weeks, the eventual end of this Bull Market is still likely only months away ... not years away. And as we work through the final stage of the Bull Market, the number of stocks participating in the advance will continue to diminish as more and more sectors get weak and gradually succumb to the influence of the coming Bear.
If you buy into this analysis, then the natural question is whether you should buy or sell out of your stock portfolio. But please understand that by following any of our Model Portfolios, you no longer need to worry whether you should be buying or selling. The models are designed to follow the market's action closely ... so you don't have to. 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. Then, the models will posture themselves to take advantage of the bear market and make some money. At the moment, our models have already begun the process of ratcheting down stock market exposure to dial back risk as the market's uptrend has shown increasing signs of deterioration.
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 and whether the analysis is right or wrong, 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 May 31, 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 |
| Energy Stock Fund | 20% | RYEIX | 15% | ENPIX | 20% | XLE |
| Corporate Bonds, or Money Market |
Money Market Fund: 20%. ProFunds investors should have 30% 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 May 31, 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. | |||||
