| Model Portfolios: | August | Y-T-D | 12 Mos. | 4 Years | 8 Years |
| Performance Xtender | 0.5 % | 3.1 % | 16.1 % | 50.2 % | 322.8 % |
| Max Xtender | 2.6 % | -0.4 % | 16.1 % | 57.2 % |
791.3 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Balanced Portfolio (60% stocks 40% bonds) | 1.0 % | 2.9 % | 10.0 % | 39.1 % | 42.2 % |
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 look at the S&P 500 Index's test of support at the 200-day moving average line and market's near-term prospects.
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 adjusted allocations at the beginning of August to significantly reduce risk to the stock market. They remain in a "neutral" posture as of the end of the month.
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 performed as expected over the full course of the most recent longer-term cycle -- the bull market cycle that began in early 2003.
- The Performance Xtender, designed to make sure an investor beats the stock market's appreciation during bull market cycles, beat the traditional balanced portfolio over the 4-year period.
- The Max Xtender, designed to deliver a multiple of the market's performance during every bull market cycle, beat the balanced portfolio by 46% over the period.
Four Year Performance Graph (As of August 31, 2007)
Super Performance Over Multiple Cycles: The models are further designed to generate super-charged performance over the very 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 4.4% per year -- not much more than you would expect from a simple bond fund or money market fund investment. By comparison, the model portfolios generated 5 to 7 times that rate:
- Performance Xtender : 8-year Compound Annual Growth Rate - 19.7 %
- Max Xtender: 8-year Compound Annual Growth Rate - 31.4 %
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
Technical Support has 'Held' ... So Far
Executive Summary: Our quantitative models continue to hold lower stock market allocations as part of a defensive posture required by a "Neutral" market reading. 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.
Last month we focused on the market's breakdown through a critical support level at about 1460 on the S&P 500 Index. We asked whether this important technical break could possibly signal the advent of a bear market. We said that while we can't rule out the possibility a bear market may have already begun, the market's longer-term uptrend is still technically intact ... as long as the S&P 500 holds above the "long term trend line" (in green).
We also pointed out that the 200-day moving average is an important technical "tripwire" to watch. The moving average has routinely provided technical support for the long term uptrend and is closely followed by investment professionals. We said that it would be key whether "support would hold" at the 200-day moving average.
Support Has Held ... So Far
As of the day of this writing, support has held in rather dramatic fashion. We have seen some of the wildest volatility experienced in the US stock market for many years. And a battle royale has played out between bulls and bears focused around the critical technical support level at 1460. The S&P 500 broke down 3 times below support ... and staged 3 recoveries back above the 200-day moving average. On the second breakdown below support, the market fell 100 points (or 7%) to test the next, lower support level at 1360 (see the lower blue line on the chart).
But We Are Not Yet Out of the Woods
The market is now trying to consolidate its gains back above the 200-day moving average and prepare for the next move higher. To prove its longer-term viability, this rally will need to clear the next level of technical resistance at about 1500 on the S&P 500 Index (see red line).
But the market's internal statistics have not been impressive during this rebound. That could change. But what was impressive was the very high level of panic selling that occurred right away as the market broke from its peak in late-July. The so-called "VIX" index, a measure of investor fear, spiked to levels that haven't been seen since before the beginning of the Iraq War. And the volume of selling in the stock market was unprecedented for the early stages of a market correction.
Clearly something is going on that should give investors pause. The proximate cause for this market stumble was a "Credit Crisis" that seemed to appear out of nowhere. The sudden crisis knocked out a pillar of strength that had helped to prop up the market -- the seemingly insatiable excess liquidity driving private equity and hedge fund appetites. In addition, market participants can no longer kid themselves that the housing and subprime mortgage problems are behind us. Now it seems the housing crisis is only just getting started. As a result, analysts and economists are suddenly asking whether a recession can be avoided.
The Spike in Volatility May Signal a Seismic Shift
A technical reading of the market cannot yet tell us conclusively whether a bear market has started or whether the market will still see new highs. But there are several strong clues that we are likely very close to a new bear market ... whether or not a new high is seen before the bitter end.
First, the bull market is getting old by historical standards. This may seem like a lame point. But then very few bull markets have lasted much more than 4 years during the last century. The ones that have were powered by emerging new economic paradigms in this country that fueled leaps in growth. Where are those major new sources of growth now? Instead of major new strengths working for us, we only seem to have major new sources of economic weakness to deal with. Given this reality, how much further can this bull market push its old age?
Another clue that we are nearing the end of the cycle is that the US stock market has recently become very "over-extended" on the basis of very long-term momentum measures. This analysis involves a bit of technical trade-craft that is difficult to explain in laymen's terms, but suffice it to say that this bull market cycle has gone a very long time without a deep correction. As a result, the market has appeared technically over-extended since earlier this year. And when the market breaks from such levels, a serious new downtrend has usually been the result.
The recent spike in volatility is another clue. The last time we had such a spike was in April of 2000 when the "tech bubble" burst. The Nasdaq Composite index never recovered from that point. The volatility spike clearly signaled a seismic shift in the market's dynamics.
The August spike in volatility may also signal that the ground of market expectations is shifting beneath us. The swiftness and severity of this "Credit Crisis" suggests a major loss of confidence that may force investor reappraisal of this economy and the market.
Yet we expect the market will make an effort at least to reclaim the bullish uptrend. The bulls want to get back to the good times and keep them rolling. Many investment managers seem to think that this market shakeout has created compelling opportunities to buy stocks cheap. But in the meantime, keep an eye on the 200-day moving average. If the market rolls over and breaks back down again through the moving average, we will then be able to say that the moving average "failed support". Such a failure will likely lead to another sharp market liquidation and possibly a new bear market.
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 31, 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 31, 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. | |||||
