| Model Portfolios: | July | Y-T-D | 12 Mos. | 4 Years | 8 Years |
| Performance Xtender | -2.2 % | 2.6 % | 12.7 % | 56.1 % | 316.9 % |
| Max Xtender | -7.2 % | -2.9 % | 16.9 % | 68.1 % |
759.0 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Balanced Portfolio (60% stocks 40% bonds) | -1.8 % | 1.9 % | 11.1 % | 39.7 % | 40.4 % |
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 traditionally balanced buy and hold portfolio consisting of 60% stock funds and 40% bond funds.
Performance Analysis: Read a detailed explanation of Model Portfolio performance covering the different time frames presented in the Monthly Tracking Report.
Market Commentary: This month we address the question of whether a bear market may have started.
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 saw declines in July as the market suffered a severe reversal. The Performance Xtender will be somewhat more volatile in the short-term compared with a "Traditional Balanced Portfolio"; and the Max Xtender will be much more volatile.
The statistical logic driving the models is designed to maximize total risk-adjusted return for the long term ... over multiple market cycles. 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 July 31, 2007)
Super Performance Over Multiple Cycles: The models are further designed to generate super-charged performance over the long term 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 a "traditional balanced portfolio" ... which in 8 years has generated a compound growth rate of only 4.3% per year:
- Performance Xtender : 8-year Compound Annual Growth Rate - 19.5%
- Max Xtender: 8-year Compound Annual Growth Rate - 30.8%
To earn 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
Has the 'Bear' Arrived ?
Executive Summary: Our quantitative models are registering heightened levels of risk in the stock market, dropping from a "Very Bullish" reading to "Neutral". This amounts to a two-step reduction of our models' posture relative to taking risk in the stock market right now. It was driven by a sudden turnaround in the direction of various statistics tracked by the models that gauge the internal supply/demand relationships within the market, combined with heavy negative selling pressure and a break of the upward trend. A "Neutral" reading means there is a significantly increased likelihood that the current action in the market could lead to a serious drop of stock market valuations. However, we call it a "Neutral" reading because there is just as good of a chance that the market's recent drop could evolve into just a correction of short or intermediate-term duration. But given the model's logical imperative to protect the model portfolios from significant loss, stock market allocations have been sharply reduced.
The stock market broke critical technical support on its weekly close on Friday, August 3rd and signaled at least an intermediate-term change of trend.
The breakdown last week in the S&P 500 Index violated a key triple support level at about 1460 (see the blue line on the chart). This level was the previous high-water mark established in February which the market took out during the recent rally to new highs. The decisive violation of this recent support level classifies the summer breakout as a "failure". By itself, a "failed breakout" signal is very bearish.
The 1460 level on the S&P 500, however, also coincided with two other important sources of technical support with longer-term significance. First, the trendline supporting the recent rally going back to its beginning in July 2006 (in green) converged at around 1460. Second, the 200-day Moving Average (in dark blue) coincided with this level.
So there was great synergy of technical support at the 1460 level ... a 'triple' support level if you will ... and it was taken out by the market's action last week. So now the critical question is whether this strong level of technical support will "hold" and pull the S&P 500 back above the 1460 level -- or whether the support will fail and trigger a much deeper drop in the market.
Has a Bear Market Begun?
While we can't rule out that a bear market may have begun, the longer-term uptrend of the stock market is still technically intact.
Whether or not the triple support level at 1460 holds, the market would need to break support at the longer- term trend line (in red on the chart above) to technically signal the potential for a bear market. Until then we must respect the uptrend and the potential for the intermediate-term downtrend to evolve merely as a correction to the underlying uptrend.
The Significance of the 200 Day Moving Average
The 200-day moving average of the S&P 500 has a long history of being followed by investment professionals. Its popularity stems from its ability to provide clues to the direction of the overall stock market.
The chart above shows the 200-day moving average (the dark blue line) mapped against the index itself and it is relatively easy to see how this simple technical indicator has been helpful.
During bull market periods the moving average has provided "support" ... that is, whenever the index drops close to, or below, the blue line stock prices have rallied and pushed the market back into another rising phase of the bull market. When the index is above the moving average, the investment community will say that the stock market is in a bull phase.
The converse is likewise true. You can see on the chart that the 200-day moving average also provided "resistance" during the Bear Market phase of the market in the years 2000, 2001 and 2002. The market index rallied up several times to touch the moving average but then fell back into renewed bear market declines. Many investment professionals were waiting for the S&P 500 to break above the moving average in a sustained fashion before declaring the beginning of a new bull market. And this break through came in April of 2003.
The 2000 Breakdown Signaled a Bear Market
You can see on the chart that the 200-day moving average also supported the bull market of the 1990's ... until October of 2000. This time the moving average failed to provide support. After the market broke down through the indicator, it made one attempt to rally back above the line which it had done successfully many times before during the entire progress of the bull market. In technical jargon, it attempted a "retest" of the support level. But it failed as you can see and the index rolled over into a 2 1/2 year bear market.
The Potential for a 'Double Top' Formation
Last week's breakdown occurred as the market was testing historically extreme levels of over-extension and also trying to exceed the high established 7 years ago when the market peaked in March of 2000.
The 'double top' formation ... and its cousin -- the 'double bottom' -- are a very common type of chart pattern found in markets at the beginning and end of important trends. We argued in our commentary two months ago that we could be witnessing a huge double top formation right now in the S&P 500 index that could potentially put an end to a 33-year 'secular' bull market cycle that began in 1975 when the S&P 500 bottomed at around an index value of 60.
But it is way too early to confirm that this is a double top. We will need to see stocks roll over into a new bear market cycle first.
Keep an Eye on the 200-day Moving Average
A good indication that we have a new bear market on our hands will come if the S&P 500 Index cannot move successfully back above the blue 200-day moving average line. At the time of this writing, the S&P 500 has staged a recovery back above the line; but the question is whether it can hold above it.
If the index can hold above the 200-day moving average then we have a good chance that the market will attempt a rally back to the previous highs.
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 stock market's appreciation as a result. Now that the market has had a serious breakdown, the Model Portfolios have substantially reduced exposure to protect their values from additional risk.
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 August 6, 2007 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Large Cap Stock Fund | 30% | RYZAX | 30% | BLPIX | 30% | SPY |
| Energy Sector Fund | 20% | RYEIX | 14% | ENPIX | 20% | XLE |
| Precious Metals Fund | 10% | RYPMX | 7% | PMPIX | 10% | GLD |
| Corporate Bonds, or Money Market |
40% Money Market Fund . ProFunds investors should have 49% 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 August 6, 2007 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| UnLev'd LargeCap Fnd | 100% | RYZAX | 100% | BLPIX | 100% | SPY |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the SPY position is un-margined. | |||||
