| Model Portfolios: | November | Y-T-D | 12 Mos. | 4 Years | 7 Years |
| Performance Xtender | 1.9 % | 10.1 % | 10.1 % | 72.4 % | 262.1 % |
| Max Xtender | 3.2 % | 21.1 % | 19.4 % | 98.8 % |
557.1 % |
| Compared to Traditional Strategy: | |||||
|---|---|---|---|---|---|
| Buy and Hold (S&P 500 Index Fund) | 1.6 % | 12.2 % | 11.5 % | 49.6 % | 8.0 % |
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 market's potential to continue its advance at this stage of its strong rally.
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
Bull Advances in November
The S&P 500 index advanced in November, rising 1.6%. The Nasdaq 100 continued its recent record of out-performance, climbing 3.4% during the month. The Small-cap Russell 2000 index also out-performed, gaining 2.5%.
The Max Xtender and Performance Xtender models both out-performed the S&P 500 with 3.2% and 1.9% gains, respectively ... this in spite of still being constrained by a "low volatility" setting in the models' logic that has kept them both concentrated in the Large-cap stock sector.
The Performance Xtender has been working through an unusual period of under-performance and still slightly trails the year-to-date performance of the S&P 500. But the 4-year cumulative returns shown below demonstrate the ability of the Model Porfolios to beat the market handily over the course of 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 indeed making money) during the bear market cycle of 2000 - 2002.
Four Year Performance Graph (As of Nov. 30, 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 earlier in the year.
But after short-term setbacks in the past, this model has always bounced back strongly and provided a superior level of performance along with excellent long-term 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 most of the recent bull market, the model accumulated a total return of 72.4% compared with a 49.6% gain for the market. Looking at a longer, 7-year period ... that incorporated a severe bear market ... the model gained a total return of 262.1% compared with a Buy and Hold investor who would have earned a total return of only 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: 20.2% per year
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 3.2% in November and has beat the market by 69% over the previous 12-month period. Over the past four years, the model produced a cumulative total return of 98.8% during what has been a bull market period. Looking at the past 7 years, this model has generated a cumulative total return of 557.1% compared with the market which has done little better than break-even at a total return of only 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: 30.8% per year
Market Commentary
Rally Bumps into Overhead Resistance
Executive Summary: Our technical indicators measuring the internal health of the market improved again this past month. However, there has not been enough improvement for our Model Portfolios to trigger the relaxation of a 'low volatility' setting designed to reduce overall portfolio risk. The portfolios have therefore remained concentrated in less-risky Large-cap stocks. However, the models are fully invested and have fully participated in this strong rally. The question for the market now is whether it can hold onto these new highs, consolidate and continue to move ahead. But given the bull market's long duration by historical standards combined with a 9-month period of deteriorating internals, we will be watching closely for any reversal here.
The stock market extended its gains in December, stringing together 5 straight "up" months since the correction lows of June and July. Having witnessed the market push above important levels of technical resistance during this run, it is time to ask how high this rally can take the market before succumbing to another correction ... or even finally putting in a peak for the bull market cycle that began 4 years ago.
Standard techniques of technical analysis can provide some insight into this question. We will look at three of these techniques and see what they suggest for each of the three major stock market averages in the United States -- the Dow Jones Industrial Average, the S&P 500 and the Nasdaq 100 index.
The above chart of the Dow shows the recent rally of the average breaking above the previous all-time high posted back in early 2000. Previous highs in an index always present important levels of "technical resistance" that serve as psychological barriers to a continued advance. So it was certainly a milestone for the Dow to break through this barrier and establish a new high. But now the Dow average must prove it can hold this psychological breakthrough and continue to move ahead. If it cannot, and proceeds to break decisively back down through the 12,000 level, it will set up a very bearish pattern we call a "failed breakout" that usually precipitates a very sharp sell-off.
Another technically significant feature of the Dow's chart is a classic "throw-over" pattern that typically precedes a final top in a bull market sequence. This pattern is identified by drawing a trend line across the periodic tops of a bull market sequence. We show this trend line on the chart in bright green, labeled as "Upper Trend Line". Notice that the Dow's recent advance has pushed it just above the Upper Trend Line. This classic throw-over identifies the current rally as the potentially final, exhaustive move of the bull market. If this interpretation is correct, then the market should be very close to its final high.
We also like to use a standard deviation band around a 45 week moving average to identify the extreme limits of major moves in the market. We have found that a band representing 4 standard deviations is the most reliable in identifying important stopping points for market extremes in both bullish and bearish directions. In the chart above, the upper envelope of the 4-standard deviation band is about 3.5% above the Dow's current price. Therefore, there would appear to be at least this much headroom for the Dow to run before it reaches an extreme level of extension.
We find a similar story in the pattern of the S&P 500 index shown in the chart above. It has also recently crossed above an important resistance level (Level B) and its pattern shows a similar "throw-over" of the Upper Trend Line. One difference however is that the S&P 500 has already reached the upper envelope band at a level of around 1410. This suggests that the rally in this index is very close to running out of steam and, at the very least, a significant correction is likely to take hold soon.
Another difference is that unlike the Dow average, the S&P 500 has still not exceeded its all-time high set back in 2000 (Resitance Level A). If the S&P 500 can successfully work through another market correction, the index will likely set sights on reaching the all-time high of around 1550. Under such a bullish scenario, the S&P 500 has another 11% of potential appreciation before hitting a major technical obstruction. A more bearish scenario would likely ensue if the S&P 500 were to break back down below Resistance Level B at about 1325, thereby setting up a "failed breakout" pattern.
The chart of the Nasdaq 100 index is different in a number of respects. First off, the Nasdaq is still working to recover even 1/3rd of the market capitalization lost in the bear market. In addition, the Nasdaq has worked its way up close to the Upper Trend Line (in bright green) but still has not registered a classic throw-over pattern.
Like the Dow, however, the Nasdaq 100 has recently exceeded an important level of resistance (Resistance Level B) and also has some headroom before reaching the upper 4-standard deviation envelope band. The index currently has about 4.5% of headroom.
Under a bullish scenario, the Nasdaq would next be looking to reach up to the next level of resistance -- Resistance Level A. This scenario would allow the Nasdaq about 16% of potential appreciation in the next move up. A more bearish scenario would likely be triggered by a decisive breakdown below Resistance Level B.
A Bullish or Bearish Interpretation? On balance, the above interpretation of the three charts is essentially short-term bearish in that it strongly suggests the three market averages are close to intermediate highs. At the very least, this interpretation suggests the strong likelihood of a major correction developing soon.
A more long-term bearish interpretation requires recognition of the long duration of this bull market by historical standards. Very few bulls have lasted much more than 4 years in length. Moreover, our battery of technical statistics that gauge the underlying supply and demand health of the market show a "tiring bull". We have witnessed a long 9-month period of serious deterioration which has been more than enough statistical weakness to kill most previous bulls.
The Models Stick With the Trend: It is interesting to note that our market commentary has had a decidedly bearish slant over the previous year ... and here we are today with a bull market that has refused to die! But in spite of our bearish commentary, our Model Portfolios have maintained a largely bullish posture and we have captured the market's appreciation as a result. It illustrates one of the core benefits of following our Model Portfolios -- their ability to follow and stick with the primary underlying trend of the market.
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 models such as these can help you reconcile the constantly conflicting views of different market gurus, economists and advisors. They provide a very 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 Dec. 3, 2006 ...
| Current Recommended Portfolio Allocations | Rydex Funds | ProFunds | ETFs | |||
|---|---|---|---|---|---|---|
| Allocation | Ticker | Allocation | Ticker | Allocation | Ticker | |
| LargeCap Stock Fund | 70% | RYZAX | 70% | BLPIX | 70% | SPY |
| Energy Stock Fund | 10% | RYEIX | 7% | ENPIX | 10% | XLE |
| Precious Metals Fund | 10% | RYPMX | 7% | PMPIX | 10% | GLD |
| Real Estate Fund | 10% | RYHRX | 7% | REPIX | 10% | ICF |
| Corporate Bonds, or Money Market |
Money Market: ProFunds investors should be holding the 9% residual in money market funds . Note that the ProFunds sector allocations have been reduced to adjust for the funds' leverage factor of 1.5 to 1. | |||||
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 Dec. 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. | |||||
