| Model Portfolios: | July | Y-T-D | 12 Mos. | 3 Years | 7 Years |
| Performance Xtender | -1.5 % | 0.1 % | 1.5 % | 38.6 % | 270.1 % |
| Max Xtender | -2.8 % | 2.8 % | -1.2 % | 43.9 % | 635.2 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | -0.1 % | 1.6 % | 2.8 % | 32.2% | 5.0 % |
Performance Analysis
Another See-Saw Month
During June and July the market saw some extreme up-and-down volatility by historical standards. In spite of all the volatility, there was no net change in the S&P 500 index in June; and again in July there was no net change. Clearly, the market cannot seem to make up its mind.
The extreme see-saw action of stocks makes it difficult for our Model Portfolios to sort out the primary trend direction of the market. Our short-term performance has suffered as a result.
But since periods like this can be frustrating, it is a good time to remind ourselves why we pursue these kinds of investing strategies. The long term is what it is all about ... plus the ability to effectively manage risk while earning attractive returns during the bull markets. Avoiding disasterous bear market losses is a key part of effectively managing risk. And so, in addition to showing a chart of the most recent 3-year period (which has been a bull market) you will also see below how the Model Portfolios performed during the bear market of 2000, 2001 and 2002.
Three Year Performance Graph (As of July 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 under-performed the market in July with a 1.5% loss. It's performance has been unusually volatile in recent months and now for the first time in a long time, the model has slightly under-performed the market on a 12-month basis.
But after short-term setbacks in the past, this model has always bounced back strongly and provided a superior level of performance along with strong risk management. Over the longer term, this model has excelled in providing the strongest ratio of return relative to risk. Looking at the past 3-years which encompassed most of the recent bull market, the model accumulated a total return of 38.6% compared with only a 32.2% gain for the market. Looking at a longer, 7-year period that incorporated a severe bear market, the model gained a total return of 270.1% compared with a Buy and Hold investor who would have earned a total return of only 5.0%. 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: 20.5% per year
The model triggered an increase in stock market exposure on July 16th, just after the recent correction bottomed, increasing the Large cap stock allocation from 40% to 80%. The remaining 20% of the portfolio is allocated to an investment in a Real Estate sector fund (real estate investment trusts).
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. The model lost 2.8% in July however it is still up 2.8% for the year. Over the past three years, the model produced a cumulative total return of 43.9% over this bull market period. Looking at the past 7-year period, this model has generated a cumulative total return of 635.2% compared with the market which has done little better than break-even with a total return of only 5.0%. 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 7-year Compound Annualized Return: 32.9% 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 elsewhere in this newsletter, the model has ratcheted back both total market exposure and its volatility setting to reduce the potential impact of any market decline.
Bear Market Performance Comparison: How your portfolio performs in the bear markets is as important as how it does during the bull markets. The strategies behind our Model Portfolios are specifically designed to "step out of the way" during bear markets to protect the value of the portfolio and also to take advantage of bear markets by selectively "going short" through an investment in a Bear Fund (also called Inverse Fund). Let's look at the Bear Market that developed following the historic bull run of the 1990's and see how our Models actually performed. The market peaked during the end of March 2000 and dropped for 2 1/2 years. Finally, it bottomed in late September 2002 and the Bear Market was over.
Bear Market of 2000, 2001 and 2002
The Max Xtender model initially lost money during 2000 since much of the market's action that year was sideways, see-saw movement. But then the down-trend got going in earnest during 2001 and the Max Xtender made gains from its postion "short" the market. By the end of the Bear Market, the Max Xtender had gained over 80% while a Buy and Hold strategy would have lost about 40%.
The Performance Xtender also goes short during Bear Markets (by investing in Inverse Funds) but does not use leverage. As a result, it was able to gain almost 70% during the Bear Market; but it did so with much less volatility than the Max Xtender model. A part of the Performance Xtender's success during this period was due to its ability to tap into gains in three "defensive" sectors: Energy, Gold and Real Estate.
Performance over Multiple Cycles: In the past seven years, a Buy and Hold strategy investing in the S&P 500 Index would today show a cumulative total return of only 5.0%! You would have done better in a bank account and also avoided the heartache of a 40% decline in the value of your portfolio combined with waiting for nearly seven years to break even.
- We endeavor to communicate to our readers the long-term benefit of avoiding losses during Bear Markets (and even better ... making some money). Mathematically, your portfolio will compound growth much faster if you avoid those 40% Bear Market losses.
Rather than gaining only 5.0% over 7 years, the Performance Xtender gained 270.1%. It accomplished this not only because of its Bull Market performance but also by compounding that with its gains during the Bear Market.
The Max Xtender gained a remarkable 635.2% during the same 7-year period while a Buy and Hold Investor did little better than break even. You can see from analyzing the above two charts that the Max Xtender realized this dramatic increase in total return not only because of its Bull Market performance but also because of its strong gains during the Bear Market.
Market Commentary
Trapped in a Trading Range
Since last fall our commentaries have followed the deteriorating trend in the market's underlying technical condition. We have urged caution and our Model Portfolios adjusted their allocations in mid-April to become more defensive. Since then, the market has broken down twice below the key 1245 technical support level on the S&P 500 index ... and rallied back. But the market has so far only accomplished the creation of a new trading range between a low of 1220 and a high of 1280 on the S&P 500. To successfully break out of this sideways pattern to the upside, the market wil need to move decisively above the 1295 level of technical resistance established by the temporary high in early June.
Stock market pundits continue their preoccupation with the Federal Reserve's next move. Will the Fed stop raising rates, or not? One day the market thinks they will and stocks launch higher. The next day the market thinks they won't and stock prices trail back off again. Meanwhile, a new war has begun in the Middle East, crude oil is trading above $75/barrel again, the Iraq situation continues to deteriorate, the economy is slowing, the federal deficit continues to grow and we haven't had our first hurricane yet.
Where is the Demand for Stocks? Whatever the pundits and media commentators might be saying about the stock market, technical indicators of the balance between supply and demand for stocks paint the picture of a steadily weakening market. Demand has been slowing since last fall; and supply (selling) has really picked up since April. We have recently had several spectacular one-day rallies with no follow through ... demand simply died. The number of stocks still in bullish patterns, hitting new highs, gets fewer and fewer as investors have fled to the relative safety of Large Cap stocks. And weakening participation can also be seen in the rising number of industrial sectors whose stock indexes have rolled over into bearish patterns. Meanwhile, the Nasdaq has lost nearly 18% of its value since it peaked out over 6 months ago on January 11th. The overall deterioration of the indicators is remarkably similar to what occurred at other times when bull markets ended. Bull markets die gradually ... they simply run out of steam, sector by sector, stock by stock ... starved for lack of demand. And then panic develops and the selling really starts.
We could be at that point in the market where we've seen the first major drop in prices, but hope remains alive and panic has not emerged. The current trading range in which the market finds itself is all about this battle between hope and panic. We have had a comparatively stong economy in the past 18 months, but stock investors are still waiting for a return. The market has gained only 2.8% in the past year and only about 4% in 18 months.
- If the market can't make a sustained move up and out of this trading range, investor sentiment may turn to panic.
But we are not completely discounting the bullish case. Bull markets, as measured by the stock averages, can go on and on, well past the time when a majority of individual stocks fails to continue to participate in the general rise. And as we have mentioned before, our own analysis of chart patterns suggests to us that one more bull market leg is possible.
Buy or Sell ? If you buy into this analysis, then the natural question is whether you should buy stocks now and position yourself for a new rally ... or alternatively if you should take a longer-term perspective and sell out of your stock portfolio because of the market's weakened condition. Our Model Portfolios recently increased their allocations to the stock market, but still remain defensively postured and invested in LargeCap stocks which are the least volatile sector of the market. (Note that the models have also recently issued a new buy signal for bonds.)
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 long-term uptrend has shown increasing signs of deterioration.
If 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 July 31, 2006 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| LargeCap Stock Fund | 80% | RYZAX | 80% | BLPIX | 80% | SPY |
| Real Estate Sector | 20% | RYHRX | 15% | REPIX | 20% | IYR |
| Corporate Bonds, or Money Market |
ProFunds investors only: 5% 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 July 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. | |||||
