| Model Portfolios: | May | Y-T-D | 12 Mos. | 4 Years | 8 Years |
| Performance Xtender | 4.0 % | 5.7 % | 11.5 % | 67.3 % | 346.8 % |
| Max Xtender | 6.0 % | 7.8 % | 25.7 % | 101.4 % |
934.7 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500 Index Fund) | 3.4 % | 8.1 % | 20.7 % | 59.1 % | 17.7 % |
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 significance of the S&P 500 Index making new all-time highs.
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
The two Model Portfolios remain somewhat defensively positioned at the present time and year-to-date have slightly lagged the performance of a hypothetical un-diversified portfolio solely invested in the S&P 500 Index -- although in May they out-performed nicely.
The statistical logic driving the models is designed to maximize total risk-adjusted return for the long term ... over multiple market cycles. But from time to time either model may under-perform an un-diversified portfolio on a short-term basis.
The chart below of 4-year cumulative returns demonstrates that the models have performed as expected over the full course of the recent bull market cycle that began in early 2003.
- The Performance Xtender is designed to make sure an investor beats the stock market's appreciation during bull market cycles.
- The Max Xtender is designed to deliver a multiple of the market's performance during every bull market cycle.
Four Year Performance Graph (As of May 31, 2007)
Super Performance Over Multiple Cycles: The models are designed to generate super-charged performance over the long term ... compared to the S&P 500 ... by helping the investor to make serious gains during both up and down market cycles. The models can usually generate significant gains during down markets by investing in "defensive" sector funds and/or "Bear Funds" that go up in value when the market is going down. This simple approach can allow an investor to compound "profits on top of profits" over multiple cycles. A review of the models' comparative 8-year returns is highly instructive because this period incorporates two complete market cycles --- a bear market cycle and a bull market cycle. By beating the market in bull markets and making money during losing periods, the two models have generated huge average growth rates compared to the S&P 500 Index ... which in 8 years only barely "broken even" for investors:
- Performance Xtender : 8-year Compound Annual Growth Rate - 20.5%
- Max Xtender: 8-year Compound Annual Growth Rate - 33.9%
Earning average gains such as these in spite of a punishing bear market requires a long term strategy that is also nimble enough to dynamically take advantage of changing market conditions.
Market Commentary
The Beginning of a New Era ... Or the End of One?
Executive Summary: Our models reduced stock market allocations somewhat after the severe breakdown in late February and have remained slightly defensive since then as the market recovered and re-tested the previous highs. While our statistics measuring the underlying supply/demand balance in the market show relative health, the overall market is now showing a negative momentum divergence from a level of extreme over-extension. As a result, we believe the models are postured appropriately to reflect the possibility of a new, more extensive correction, should this develop.
May 2007 will be significant in the annals of stock market history because the widely-followed S&P 500 Index finally closed at a new all-time high after 7 years in the wilderness. The index had previously peaked on March 24th, 2000 at the end of the "tech boom" era.
The media have treated the market's new all-time highs as something to celebrate. In a way it is important, because all the buy-and-hold investors who have been sitting on porfolio losses since 2000 can now celebrate that they are finally back to break-even. Even though they've earned a zero rate of return for 7 years, at least they can console themselves knowing they didn't lose their principal.
But what is the longer-term significance of the market making new highs? Is it now safe for small investors to get back into the market? Does it signify the beginning of a bold new uptrending market? Or could it possibly be the end of a boom era?
- We think there is a very large-scale pattern developing now in the market that suggests we are witnessing the end of an era.
A Double Top Formation -- The Last Hurrah?
There are patterns to the markets ... recognizable patterns that tend to repeat themselves. The easiest way to think about why there are such patterns is to simply recognize that they are "signitures" of the underlying psychological forces driving a market -- and psychology is fundamentally a human trait that will repeat over and over in similar circumstances. The type of pattern we are talking about in this case is something called a "double top." It is a very common pattern that often signals the termination of market rallies and up-cycles of any duration -- be it days, months, years or decades. Indeed, there are also many "double bottoms" to be found that signal the end of a down-cycle.
The recent new high in the market is very clearly a "double top", as the chart shows. Now the question is whether this particular double top signifies the exhaustion of the bull market or whether stocks will continue to run and completely eclipse current price levels as economic growth charges ahead into the future.
End of a Bull Market SuperCycle?
The more important message from this double top is its potential significance on a much larger scale. We are talking about the "supercycle" scale of the bull market in US stock prices that began when the market formed a major long-term bottom in late 1974. As you can see in the chart above, stock market prices have been going up -- way up -- ever since for 33 years. This has represented a long-term period of economic growth, spanning generations, that might be called a "supercycle". It was punctuated by two sharp and severe "bear markets": the stock market crash of 1987 and the tech market crash of 2000-2002.
- We believe the significance of the current double top is that it may well herald the end of a 33-year Bull Market Supercycle.
We recognize that this is a very bearish statement. We are saying that this may be the end of the post-Vietnam War era and the economic dynamic that went with it.
What do double tops represent psychologically? They represent "exhaustion" ... the exhaustion of a previously entrenched psychology. Look around you at the world and what is going on. Think about it. Does it seem to you that the United States are at the beginning of a bold new era of growth, or more likely at the end of one?
Nasty Structural Problems
After three decades of fabulous growth, the US economy is now beset by an array of nasty structural problems that form a significant barrier to growth. The American consumer may be having his final hurrah before having to face up to multi-year trends of declining savings, growing debt and a new collapse in housing wealth. Our severely energy-dependent economy is just beginning to grapple with the sharply rising cost of gas and oil and its ripple effect across many sectors of the economy. Our import-dependent economy is also just beginning to feel the inflationary effects of a falling US Dollar as its former preeminance as the world's "reserve currency" is eclipsed by new global forces. Commodity prices have launched a new inflationary up-cycle, breaking out of a 22-year downtrend, driven by galloping world demand. And interest rates may be getting ready to move higher on a long-term basis after falling for 26 years.
The bottom line is that the core strengths of the US economy have been hollowed-out by the forces of globalization and a nagging dependence on carbon-based energy and hugely expensive medical care. Our worldwide leadership in technology has been diminished by an unbelievably rapid migration of technical skills, theoretical knowledge and capital to emerging markets as American students drop further every year in math and science rankings. The untamed growth of health care costs are driving US corporations and state & local governments toward potential bankruptcy. And we have squandered the huge government budget surpluses of the 1990's in the pursuit of a war that has humbled the US military.
Reversion to the Mean
Taking in the whole picture, it seems likely to us that the US stock market is getting ready to "revert to the mean". The 33-year Bull Market Supercycle has taken the market way above its long-term average Price/Earnings Ratio. And when it does revert to the mean, history tells us that it will "over-correct" on the downside like a pendulum.
Whether the mean-reversion will take the form of a formidable crash, a depressionary bear market cycle, or a stagflationary supercycle -- no one can know. But we can probably surmise that the next major down-cycle will force fundamental change upon this country and our economy since we will have no choice but to discover real solutions to the many structural problems we face. To position this country for a whole new cycle of superior growth, time will be required and quite a lot of pain.
The End of an Era
Every era has its own character and personality. What will come to symbolize the post-Vietnam War era in America? Will it be the gas-guzzling SUV, a peculiarly American creation introduced to help consumers celebrate the wealth and convenience afforded by the peak production years of global oil? Will it be the final collapse of the Cold War, the emergence of US military supremecy and the fleeting belief in the end of global conflict? Will it be the excesses of the Boomer generation whose final retirement may finally end consumerism as we know it? Most certainly, this era will be remembered for the birth of the personal computer and the internet and their revolutionizing impact on just about everything.
But the point is that every era, every economic supercycle, grows out of its own unique and fundamental circumstances that lend it its own special character. The previous Bull Market Supercycle in the US before the current one also happened to last 33 years. It began in 1932 as the Stock Market Crash of 1929 bottomed and the country began to work its way out of the Depression; it continued through World War II, the Korean War and the first half of the Vietnam War until 1965 when the stock market peaked. This entire period could be seen in retrospect as the culmination of heavy industrialization as the core economic dynamic.
The Bear Market cycle from 1965 to 1974 represented a major transition ... a coming to terms with the core structural problems created by the post-Depression industrial supercycle. America struggled and grappled with those forces until something new emerged; and then the 1980's witnessed the flowering of a wholly-new era. Fast forward to 2007 and we have fully reaped the benefits of the wholly new economic dynamic and pushed its underlying forces for all they were worth. Now we face the structural limitations of those forces and the consequences of this era's inherent contradictions.
We are inclined to believe that the current bull market in stocks is the last hurrah, the final movement, of a 33-year old bull market supercycle. The new transition period we are about to enter may well be seen historically as the demarcation between the American Century and the emergence of a whole new global economic dynamic. It may also be seen in retrospect as the passing of an entirely carbon-based energy infrastructure to something else. It should also mark a new acceleration of the digital revolution and the myriad fundamental changes wrought by it.
The Models Stick With the Trend: It is interesting to note that while our market commentary has 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 "quantitative" 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 May 31, 2007 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Large Cap Stock Fund | 60% | RYZAX | 60% | BLPIX | 60% | SPY |
| Energy Sector Fund | 20% | RYEIX | 14% | ENPIX | 20% | XLE |
| Corporate Bonds, or Money Market |
20% Money Market Fund . ProFunds investors should have 26% in money market. | |||||
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, 2007 ...
| 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 Fnd | 50% | RYZAX | 50% | BLPIX | - | - |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the SPY position is margined 1.5 to 1. | |||||
