| Model Portfolios: | August | Y-T-D | 12 Mos. | 4 Years | 7 Years |
| Performance Xtender | 2.0 % | 2.1 % | 4.0 % | 69.1 % | 281.0 % |
| Max Xtender | 3.2 % | 6.1 % | 7.5 % | 122.5 % | 667.4 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | 2.1 % | 4.5 % | 6.9 % | 48.6 % | 6.3 % |
Performance Analysis
Up in August
The market gained 2.1% in August and rallied close to the highs set in early May. But stocks have continued a pattern of see-saw, up and down churning ... and despite a year of solid economic growth and corporate profits, the S&P 500 Index is ahead by only 4.5% since January 1st .
There have been plenty of headwinds holding stocks back, including raging energy prices, inflation worries, terrorist states seeking nuclear weapons and a war in the Middle East.
The extreme see-saw action of stocks makes it difficult for our Model Portfolios to sort out the primary trend direction of the market and our short-term performance has suffered as a result.
But the 4-year cumulative returns shown below demonstrate the ability of our Model Porfolios to beat the market during a bull market cycle. Our longer-term 7 year returns (shown in the table above) reflect the additional, enormous benefit of avoiding significant loss (and even making money) during the bear market cycle of 2000 - 2002.
Four Year Performance Graph (As of Aug. 31, 2006)
Results in the Performance Xtender model : This model is our most sophisticated strategy for growth investors who have a moderate risk tolerance. The model gained 2% during August in line with the S&P 500 index. However, the model's 12-month and year-to-date performance has been adversely affected by losses taken in two sector investments this year.
But after short-term setbacks in the past, this model has always bounced back strongly and has 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 4 years which encompassed all of the recent bull market, the model accumulated a total return of 69.1% compared with only a 48.6% gain for the market. Looking at a longer, 7-year period that also incorporated a severe bear market, the model gained a total return of 281% compared with a Buy and Hold investor who would have earned a total return of only 6.3% holding an index fund in the S&P 500. 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: 21.1% 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).
Results 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 2-times leverage, the maximum allowed for this Model Portfolio. The model gained 3.2% in August and has beat the market over the previous 12-month period. Over the past four years, the model produced a cumulative total return of 122.5% during what has been a bull market period. Looking at the past 7-year period, this model has generated a cumulative total return of 667.4% compared with the market which has done little better than break-even with a total return of only 6.3%. 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: 33.8% per year
This model is now aggressively postured in Large Cap stocks, with a 200% allocation to the stock market (leveraged 2-to-1). This model is designed to "swing for the fences" during both bull markets and bear markets, but it exercises risk management controls to maintain an attractive ratio of risk to potential reward.
Market Commentary
Market Action Confirms Bullish Signal ... but Narrowly
Executive Summary: Recent action in the S&P 500 index has confirmed the end of the correction begun in May. Reflecting the reduction of downside market risk, our model portfolios have shifted from defensive to moderately bullish postures. But many sectors and market indexes remain in bearish trading patterns, reflecting narrowing buying interest and a flight to quality. We believe the pattern of market deterioration is consistent with the historical character of a terminating bull market.
A month ago, the market still had not demonstrated whether the rally off of the lows in July had been anything more than a "dead cat bounce". A very bullish signal we call a Failed Breakdown had occurred, but the market needed to decisively move above the key 1295 resistance level on the S&P 500 index to provide technical confirmation of the signal. Our skepticism was high because of the serious deterioration we had seen in our longer-term measures of the market's underlying health.
But the S&P 500 mustered enough strength in August to break above 1295 and provide the bullish confirmation we were looking for. The S&P 500 also moved decisively above the widely-followed 200-day moving average (blue line on the chart) which many fund managers use to signify whether the market is in a bull market or not. By the end of August, the S&P 500 had traded to within 1.6% of the high established back in May before the correction started.
By late August, our models also had read enough reduction in downside risk to trigger a shift to fully bullish postures. However, in view of the continued poor condition of the market's underlying technical statistics, the models remain on a low volatility setting which is designed to reduce their vulnerability to any downside (see expanded discussion in the September 3, 2006 Trade Alert).
Since last fall our commentaries have followed the deteriorating trend in the market's underlying technical condition. We have urged caution and in mid-April our Model Portfolios adjusted their allocations to become more defensive. Since then, the S&P 500 has broken down twice below the key 1245 technical support level on the S&P 500 index ... and rallied back.
- But many sectors within the market have not recovered from their bearish breakdowns; and the narrowing participation shows a "flight to quality" mentality among investors that typically accompanies the final stages of bull markets.
Smallcap Stocks Remain in Bearish Pattern: The chart above shows the Russell 2000 small cap stock index. You can see that the index is still 10.9% below the May highs ... in stark contrast with the Large Cap oriented S&P 500 Index. The Russell 2000 index has not broken above its 200-day moving average nor has it moved back above key resistance defined by the recent trading high in late June. In short, the Small Cap stock sector has not yet broken out of a bearish pattern of lower lows ... and lower highs.
Small cap stocks may yet "catch up" with the Large Cap sector, but their current inability to confirm the recent bullish turnaround in Large Caps is one demonstration of the narrowing participation in the bull market.
- Out of Fidelity Investments' 41 individual sector funds, we only count 14 that are currently in a confirmed bull market trend pattern. During healthy bull market periods, almost all of them are bullish.
The NASDAQ is Also Still Bearish: As seen in the chart above, the Nasdaq 100 Index is also over 10% below its highs. It has rallied strongly recently, challenging an important level of resistance. But the index has not moved above it yet and has also not broken above its 200-day moving average. The bearish pattern of the Nasdaq provides additional evidence of the weak foundation under what remains of this bull market.
- The message we have tried to get across to our readers is that what we are seeing is an historically typical pattern of the terminal stages of a bull market. Bull markets die gradually as increasing numbers of stocks and sectors roll over and fall out of their bullish uptrend patterns. Investor interest narrows and volume dries up. At some point panic sets in, investors run for the exits and the increased selling pressure drives the entire market into a bear market cycle.
Model Portfolios Adjust to the Market: Our computer models analyze these patterns of deterioration in the market and turn more or less cautious based upon histiorical statistical relationships. But the models do not "fight the tape". If the market is moving up, the trend-following logic of the models will keep our Model Portfolios in a fairly bullish posture. That is what is happening now. In spite of the poor condition of the market's underlying statistics, our Model Portfolios are fairly bullish at the moment because of the strength of the S&P 500 index.
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 four years. Then, the models will posture themselves to take advantage of the bear market and make some money.
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.
- Our models 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 Sept. 3, 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 Sept. 3, 2006 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Lev'd LargeCap Fund | 100% | RYTNX | 100% | ULPIX | 200% | SPY |
| Corporate Bonds, or Money Market |
ETF Investors: Note that the SPY position is margined 2-to-1. | |||||
