| Model Portfolios: | September | Y-T-D | 12 Mos. | 3 Years | 6 Years |
| Performance Xtender | 2.2 % | 5.9 % | 14.8 % | 63.3 % | 268.5 % |
| Max Xtender | 0.5 % | -8.1 % | 9.5 % | 90.2 % | 593.9 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500) | 0.7 % | 1.1 % | 8.6 % | 48.5 % | -3.8 % |
Performance Analysis
September Holds onto Gains
After losing 1.1% in August, the market held firm during September in the face of historic hurricanes and a huge increase in gasoline prices. Trading essentially sideways, the market ended the month with a small net gain of 0.7%. The indexes for Small Cap stocks, Mid Caps, and Over-the-counter Nasdaq stocks all ended with similar small gains. Many international stock indexes, however, posted significant gains and our investments in Large Cap International funds outperformed the US market indexes.
The Performance Xtender: This model portfolio posted a strong 2.2% gain in September, largely on the performance of its investments in Gold stocks and Energy stocks.
As of the end of September, this model is fully invested in the stock market but is now 40% allocated in the defensive sectors of Gold and Energy stocks. In addition, the portfolio is 40% allocated in International stocks and is 20% in Small Cap stocks -- both being sectors which have continued to out-perform the broad market.
The Max Xtender: This model is still allocated in a fully bullish posture, using 100% leverage. With the sideways movement of the US stock market during September, the model posted only a 0.5% increase.
As of the end of September, this model is using 100% leverage and positioned in the more volatile Mid Cap and Small Cap sectors. The model is set to fly … if the market cooperates here with more upside action.
Three Year Performance Graph (As of September 30, 2005)
Bull Market Performance: It was exactly 3 years ago that the stock market established its lows after the devastating bear market that began in 2000. As a result, the "Cumulative 3-Year Performance History" shown above is a perfect representation of our Model Portfolios' capabilities during bull market periods. By contrast, the "Cumulative 7-Year History" shown below demonstrates their performance vs. Buy and Hold over multiple cycles of Bull and Bear.
Seven Year Performance Graph (As of September 30, 2005)
This is a good time to talk about how our different Model Portfolio strategies are designed to perform in Bull and Bear markets and what the historical record actually shows.
The 3-Year chart above is a clear representation of historical performance during the 3-year Bull market. You can see that the Max Xtender model has substantially out-performed a Buy and Hold strategy ... which is what it is designed to do in Bull markets. Using 2 to 1 leverage during strong market conditions, it should roughly gain twice what the market earns; and that is roughly what it accomplished during this Bull cycle. You can also see from the chart that the Max Xtender's gains are subject to a higher degree of volatility. This is a natural side effect of using leverage. But in the end, this model's risk-adjusted return is much better than Buy and Hold over multiple cycles.
The 7-Year chart looks at the previous Bear market and the end of the Bull market before that. You can see from it that the Max Xtender not only produces major gains during Bull markets, but also during a Bear market. This model selectively goes "short the market" (with an Inverse Fund) during parts of a Bear market and even periodically doubles its short position with 2 to 1 leverage. So it is designed to take major advantage of Bear market conditions; and its stellar performance during the 2000, 2001 and 2002 Bear years demonstrates this.
In the 3-Year chart you can also see that the Performance Xtender model has delivered about a 20% performance improvement over a Buy and Hold strategy during the Bull market. This is a fair representation of what to expect from this model's capabilities during Bull markets. First, it takes advantage of performance differentials between different sectors (such as Small Cap, International or Large Cap stocks). This ability enhances performance. Second, the model can selectively take advantage of strength in three defensive sectors: Gold, Energy and Real Estate stocks. Combined, these capabilities not only help the investor capture the potential for gains in a Bull market cycle, but also
- extend the performance of a traditional portfolio strategy, allowing the investor to capture more than 100% of the market's gain.
The 7-Year chart shows that the Performance Xtender is also extremely capable during Bear market cycles. Like the Max Xtender model, the Performance Xtender can "short the market" through periodic investments in an Inverse (or Bear) fund which goes up in value when the market goes down. The only difference is that the Performance Xtender does not use any leverage. As a result, this model produces very little volatility. You can see on the chart how "smooth" the line is. This model produces a very high risk-adjusted return over multiple cycles.
The bottom line is that the Performance Xtender and Max Xtender models are engineered to accomplish two key results: First, to beat the market handily during Bull markets; and second, to make money (while avoiding losses) during the Bear markets. The combined effect is a compounding of profits on top of profits, accelerating portfolio growth over a number of years.
Market Commentary
What a Change 60 days Can Make
At the beginning of August, the market looked very good from both fundamental and technical perspectives. Fundamentally, economic indicators seemed to finally indicate a strengthening economic picture. Technically, the market had just staged a very significant breakout, establishing new 4-year highs. Moreover, our battery of technical indicators of the market's underlying supply/demand condition were still showing very positive levels, suggesting that the bull market had some decent life left to it.
But 60 days later, the picture seems remarkably different ... and for the worse. Fundamentally, hurricanes Katrina and Rita delivered a body blow to the economy. Apart from the lost GNP and cost of recovery, the hurricanes' severe impact on the oil and natural gas industries is bound to inject a huge cost increase into the economy that will both reduce consumer discretionary spending and create a real potential for new inflation. The term "stagflation" is once again being heard.
Technically, the underlying health of the stock market has deteriorated markedly. We have previously discussed how the end of bull markets is presaged by warning signs given off by a range of technical indicators. The warning signs began in earnest during August. Looking back at market history, the pattern of deterioration we are seeing right now suggests that the current bull market has only a handful of months left.
Trading Range Breakout Holds: But in spite of the deteriorating fundamental and technical picture, the market averages have held up. The July breakout to new highs has held throughout August and September as market action turned corrective and successfully tested technical support at the point of breakout (about 1220 on the S&P 500 Index).
- As a result, the technical analysis remains positive for the market over the next several months ... as long as the market's breakout continues to hold and prices move up from here.
This combination of a positive market with deteriorating underlying fundamentals and technicals tells us that we have likely reached the final, mature stage of the bull market that began three years ago. In our January commentary early this year we said that we didn't expect this bull market to carry much beyond the end of 2005 ... and there was a significant risk it could terminate before the end of the year. Given the current analysis, our view hasn't changed. But as long as the market's action continues bullishly, our Model Portfolios will remain bullishly postured.
Technical Analysis: This month’s chart looks at the evolving bull market in Gold stocks, tracking a parallel bull market in the actual commodity. The chart shows a series of technical breakouts from a series of multi-quarter corrections. Every one of these breakouts triggered substantial rallies. The current breakout of two weeks ago may trigger a similar run ... a sharp move up creating gains of perhaps an additional 30% to 40% from here. (Note that the Performance Xtender model is now invested 20% in Gold stocks).
Higher Inflation on the Horizon : The renewed bull market in Gold is, among other things, reflective of rising concerns about accelerating inflation, driven by growing global competition for natural resources and essential materials. We have lived with the scare of "deflation" now for years; but the rising costs of essential commodities to support economic growth may have begun to offset the global forces of deflation. The new growth dynamic in Asia and other emerging markets seems increasingly resistant to any dramatic reduction. As a result the world may be plagued by an ever-increasing problem of ramping up demand for a diminishing supply.
- Rising inflation is not the only factor driving Gold prices higher. But inflation is enough of a concern, by itself.
Our economy has been supported recently by a series of unsustainable trends made possible essentially by reducing interest rates and their positive effect on home real estate values which account for a large portion of US household wealth. As inflation ratchets higher, interest rates will inevitably follow higher. Combined with the negative impact of rising energy costs, a significant rise in interest rates would constitute a double-whammy on our economy's health.
And so a picture is now emerging of the various economic forces that could put a stop to the bull market and economic recovery we have enjoyed for the past three years. Increasingly it looks as though the US may be following a pattern similar to Japan's post-bubble decline. As the global growth dynamic shifts to emerging markets, the US may drop into a new round of retrenchment with a corresponding drop in stock market valuations.
Model Portfolios Will React to Change: But our Model Portfolio strategies will react to the changing market conditions. They will exit from the stock market when the bull market ends, preserving the precious gains made over the past three years. Our "Performance Extensions Series" models (the Performance Xtender and Max Xtender) will be able to "go short" the market by investing in Inverse (or "Bear") funds and make good money as the market drops. And our Performance Xtender model will take advantage of bull market trends in Energy and Gold (indeed, as it already has!) ... while all of our models can invest in large-cap international stocks if they continue in a postive trend.
Recommended Model Portfolio Allocations
Model Portfolio: 'Performance Xtender'
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| SmallCap Fund | 20% | RYAZX | 20% | SLPIX | 20% | IWM |
| Gold Stocks Fund | 20% | RYPMX | 15% | PMPIX | 20% | GLD |
| International Stocks | 30% | RYEUX | 40% | UEPIX | 40% | IEV |
| Energy Stock Fund | 20% | RYEIX | 15% | ENPIX | 20% | XLE |
| Corporate Bonds Money Market |
10% Money Market (only if following Rydex or ProFunds). For ETF investors, we recommend using a gold stock fund rather than the ETF 'GLD'. | |||||
Model Portfolio: 'Max Xtender'
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| Lev'd SmallCap Fund | 50% | RYTNX | 50% | UAPIX | 100% | IWM |
| Lev'd MidCap Fund | 50% | RYTNX | 50% | UMPIX | 100% | MDY |
| Corporate Bonds Money Market |
Note: Since Rydex does not offer leveraged funds for either SmallCap or MidCap stocks, we have substituted a leveraged LargeCap fund, RYTNX. | |||||
