October 2006 Newsletter

Monthly Performance Tracking Report ( Total Return as of September 29, 2006)

Model Portfolios:	September	Y-T-D	12 Mos.	4 Years	7 Years
Performance Xtender	1.6 %	3.7 %	3.3 %	68.4 %	280.1 %
Max Xtender	4.3 %	10.7 %	11.4 %	111.1 %	670.4 %
Compared to Traditional Strategy:
Buy and Hold (S&P 500)	2.4 %	7.0 %	8.7 %	61.5 %	16.8 %

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 Dow Jones Industrial Average hitting all-time record 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

September is the Exception to the Rule

Septembers have had a strong historical tendency to be "down" months. But this time around the S&P 500 gained 2.4%, proving to be the exception to the rule. The gain added on to a 2.1% increase in the previous month, pushing the S&P 500 index up to close near its 5-year highs. Two months of back-to-back gains is also somewhat exceptional given the churning action we have experienced all year.

The Max Xtender model portfolio has performed as expected this year. The market's choppy, see-saw action has generated a high level of volatility given this model's use of leverage. But the strong rally of August and September has propelled the model back into the winner's column. By contrast, the Performance Xtender model has been working through a rare period of under-performance, caused by an exceptional level of volatility experienced in two sector investments this year.

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, having experienced a maximum peak-to-valley loss ("maximum drawdown") of only -8.5% in the past 7 years. [Editor's Note: compare this to a -45.1% maximum loss experienced by a "buy and hold" investor in an S&P 500 index fund]. The model has under-performed the S&P 500 Index this year, and for the past 12 months, having 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 68.4% compared with a 61.5% 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 280.1% compared with a Buy and Hold investor who would have earned a total return of only 16.8% holding an index fund tracking 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: 21.0% per year

The model is currently positioned with an 80% allocation in a Large Cap stock fund. 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. Yet it has experienced a maximum peak-to-valley loss ("maximum drawdown") of only -31.5% in the past 7 years. [Editor's Note: compare this to a -45.1% maximum loss experienced by a "buy and hold" investor in an S&P 500 index fund]. The model is currently using 2-times leverage, the maximum allowed for this Model Portfolio. The model gained 4.3% in September and has beat the market over the previous 12-month period. Over the past four years, the model produced a cumulative total return of 111.1% during what has been a bull market period. Looking at the past 7-year period, this model has generated a cumulative total return of 670.4% compared with the market which has done little better than break-even with a total return of only 16.8%. 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: 33.9% 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

Dow at Record Highs ... So What?

Executive Summary: Our model portfolios have benefited from the market's rally this month and from the relative strength of Large Cap stocks in which the portfolios are concentrated. But as the Dow hits all-time record highs and the Large Cap S&P 500 returns to 5-year high levels, other market indexes are struggling ... reflecting a process of increasing selectivity among investors that has been narrowing the demand for stocks over recent months. Many sectors and indexes remain in bearish trading patterns and increasing numbers of individual stocks have not recovered from the recent correction. We believe the pattern of market deterioration is consistent with the historical character of a terminating bull market. Reading the heightened levels of risk in the market, our quantitative models continue to dictate a low volatility setting in the portfolios which keeps us concentrated in Large Cap stocks, affording a higher degree of safety.

The financial news media have been at their myopic best this past week, loudly proclaiming the significance of the Dow Jones Industrial Average reaching all-time record high levels. It is typical of the financial press to focus on the wrong things and to glean the wrong message from developments. Rather than being a picture of market strength, the market's current performance is a display of weakness.

Simply put, the 4-year bull market is running out of steam. You can see its gradual deterioration in many different statistics that gauge the underlying health of the stock market. Perhaps the most obvious sign of weakness is the disparate performance of various market indexes that cover different segments within the market. During the healthy portions of bull markets, broad investor demand for stocks "lifts all boats." All of the indexes tend to benefit. As a bull market weakens, investor demand becomes more selective and there is a natural tendency for investors to engage in a "flight to qualtity." The typical pattern is for increasing numbers of market indexes to lag in performance and fail to confirm the new highs posted in a high quality index such as the Dow.

Large Cap Leadership Signals Weakness

Remember that the Dow is only 30 stocks ... 30 extremely large, high quality stocks that investors flock to in times of uncertainty. A broader index of Large Cap stocks is the S&P 500. The fact that this index is now hitting 5-year highs reflects the current strength of Large Caps in general. However, in contrast to the Dow, the broader index remains 11.5% below its all-time highs. Even among this higher quality universe of stocks, investors have favored only the very largest ... so the broader S&P 500 index lags the Dow. This picture is not one of market strength but rather of increasing investor caution and fear.

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% below the recent May highs ... in stark contrast with the Large Cap oriented S&P 500 Index. Mid Cap stock indexes are showing much the same picture.

Investors are showing fear of the future. They are voting with their pocketbooks by pulling out of Small Cap and Mid Cap stocks and shifting to the relative safety of Large Caps. As bull market cycles gradually fall apart, it is not at all unusual to see certain market indexes fall into bear market trends before others follow.

• Since the Small Cap and Mid Cap indexes remain locked in bearish trading patterns, it is possible that they have already moved into a new bear market cycle while the Dow, representing only 30 large stocks, is hitting all-time highs.

The NASDAQ is Still Bearish: The chart above shows just how far the Nasdaq index has fallen behind the Dow. It remains 65% below its 2000 peak. This index supposedly represents the most dynamic segment of the U.S. economy, but it hasn't even recovered one-half of its former value. And more recently, the Nasdaq remains 5% percent below the highs it posted in January. Despite the recent jump in technology stocks, the Nasdaq may still be locked in a bear market pattern that began 8 months ago!

• 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.

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. During July and August, the models gradually increased stock market allocations as the S&P 500 index recovered. But the model portfolios remain on a conservative volatility setting and will stay concentrated in Large Cap stocks until underlying market conditions change.

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. 29, 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. 29, 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.