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Buy
and Hold is Not the Problem
It's Being in the
Wrong Asset Classes
by Robert B. Gordon,
Sc. D.
November 29, 2003
Published December 1, 2003
A READER WRITES
"Since this money has to last me the rest of my life I am looking for someone I can trust to help me invest. I have attended several brokerage house seminars and had a couple of them prepare financial plans. They seem honest and I have developed a nice report with one of them. These are not dishonest people but I fear they are mistaken in their buy and hold approach of equities and bonds. When I asked a few of the questions you graciously provided in one of your editorials, I did not get satisfactory answers. This makes me nervous and the bear scares me".
I tend to forget that I am constantly getting new readers, so the purpose of this essay is to reinforce what I have been teaching for two years. The big problem for investors of all ages at this time can be summarized as follows
1.
Wall Street and the public press are wildly bullish after 4 years of
bear market.
2. Government and Federal Reserve propaganda is heavily slanted to
bullish.
3. Economists who failed in 1929 are failing again to understand
the bear market.
4. Market analysts and mutual funds are still recommending
conventional stocks.
5. Mutual funds cash reserves are at dangerous low levels of
previous market peaks.
With virtually everything they hear and read being bullish, it is completely understandable why inexperienced investors are heavily invested at the worst possible time when the bear market is poised to resume. The lessons learned in my 63 years of investing thru bull and bear markets are largely falling on deaf ears. I have failed miserably to help my retired neighbors. Strangely, they did prepare in part for Y2K, a strange event that had never happened before. But they cannot believe in a market mania that has happened many times in past history. I’m afraid that many of them will lose heavily in the next few years and be unable to recoup their losses.
WHAT MORE CAN I DO TO HELP MY READERS?
I am willing to keep trying to convince readers that we face a real threat - one that I consider to be worse than anything I have yet faced in my 88 years. I have long given up trying to convince the general public and have been concentrating my efforts on those who come to the internet seeking help. I have developed simple portfolios with encouraging back testing over the past three bear years.. Of course I have benefited from use of a computer and the great information sources now available. My learning has continued at a higher level in the past two years as a result of the research I have done for my readers. I have suggested quite a few different portfolio ideas that I believed have merit for a bear market climate. It would help me get my message across if more readers would question me about the more important issues like asset classes instead of about fund names. The size of a fund company or a sexy fund name have little to do with picking and using a fund designed to grow assets in a long bear market.
ASSET CLASSES FOR BEAR MARKETS
There is no mystery about which asset class are favored for a bear market climate. The big question is why they are not being favored by more mutual funds. In my last essay I presented a table of how many of these bear market favorites are being offered by 9 large fund companies. It was rather pathetic to find that large companies like Vanguard and Fidelity offer very few of these asset classes. I am not aware of any major companies offering a new short fund, for instance, or a new global bond fund, both of which are essential for this market Their executives apparently are still living in a past bull market environment. The end result is that tens of millions of investors are completely unaware of the best funds for bear markets. What this means, of course, is that a small group of investors using the internet have access to the best bear funds. Let’s discuss these special funds, grouped into a stable and volatile category.
The important stable classes are:
1.
U.S. Treasury bonds of short to intermediate maturity
2. Foreign Government bonds of short to intermediate maturity.
3. "
"
"
" with an added gold position
4. Special income fund with 30% hedge protection in down markets.
5. Special stock fund with a 100% hedge
"
" ".
The U.S. Treasury bonds or funds are yielding only modest income at present, and even worse, the value of the U.S. dollar has declining for months and is continuing down as we write. This can be compensated by owning an equal dollar amount of bonds in a foreign denomination. The other 3 funds have been discussed in our previous essay. Please note that we usually suggest a minimum of 50% of the assets be in these stable asset classes to provide a stable base to both assist and benefit from our regular portfolio rebalancing program.
Some major volatile classes are:
6.
Inverse bond short fund.
7. Inverse stock index short fund
8. Inverse stock short fund with an added gold position
9. Precious metal stocks and mutual funds
10. Gold and silver bullion stock or metals
11. Natural Resource stocks or fund - gas, oil, coal, lumber
12. Real Estate (REIT) stocks or fund.
We have, of course, been featuring these very important volatile bear market classes in smaller percentages in many prior essays. We use the first five (6-10) in portfolios for all intended durations and the last two for young people with a long investing life ahead of them. These assets are considered to have lasting value and will survive whatever bear market hazards lie ahead.
BUILDING A SERIOUS PORTFOLIO
In our latest essay we published 3 very small conservative portfolios designed for novice investors. These were intended for use as the investors thought best for their purposes. They could readily be modified to be more or less conservative. I badly need to hear from some novice investors because, hard as I try, my long investing career will not let me put myself in their place. As the designer of many portfolios, some much more volatile than in my essays, I have the ability to do any mid course corrections that become necessary. It is unfortunate but true, that actual experience in the market with your money at risk is the only teacher that I can recommend.
I urge readers to go to my last article and try one or more of the 4 suggested portfolios. The dollar requirements are not high and in several years you will be ready to graduate to a more rewarding portfolio. I know of no other way to learn to cope with a real bear market environment.
A SERIOUS INVESTOR WRITES
I was very pleased to get a fine letter from a young investor who has just made the conversion from conventional investing to a conservative, balanced bear market plan intended to be maintained by periodic rebalancing:
"I switched out of the 6 standard funds that the company allows for us in March of this year. Those dollars went into a money market account waiting for me to invest in any fund I should so choose. Well, I procrastinated and just let it sit there because I was a little overwhelmed about what to do with it! I'll admit that I was a little frustrated after reading some of your articles because you wouldn't recommend particular funds. I realize now that was a wise decision on your part, because it forced me to do my own research. After several months of study of your articles and using the wonderful research tool of the internet I made the plunge! In September of this year I made my first portfolio, and I'll emphasize the word my, because that's what it feels like after all that studying!
I am looking forward to rebalancing my portfolio after 6 months per your various articles. I agree with you on the dismal outlook for our country and economy over the next decade. It is amazing to me how many people that I talk with don't see the coming storm! God willing, I have about 25 years left to work and hope to maximize my family's financial future by doing my own investing! Once again, I am so glad that you share your wisdom and wish you well. Keep on writing."
Please read the letter carefully and note that, though reluctant, he finally did his own fund research and is now happy that he has his own personal portfolio. I sincerely hope that it will encourage many others to do likewise for in my opinion this is the only way to become an experienced investor. My goal from the beginning has been to help every serious reader reach this goal. The information sources are now available, so please use them so that it will truly become "your" portfolio.
I hope every reader will recognize that mutual funds in the same asset class will tend to vary in price as the entire group, not as individuals. With volatile assets such as precious metals, the leader in performance may change every year or even sooner. Small funds in asset size may have a temporary advantage over a larger fund because a single high performance stock would have a greater effect. As funds grow in size, their performance tend to be near to the group average.
BECOMING A KNOWLEDGEABLE BEAR
The long 13 month rally in the fourth year of the bear market brought bullish opinions among financial advisors and the general public to heights seen only in late 1999 and in some cases at the highest levels ever seen. A small number of previously bearish "experts" joined the bulls citing a variety of reasons, all of whom ignored the fact that very low stock valuations must be present at major market bottoms. However the relatively small group of Elliott Wave followers in this country and abroad held fast to their bearish views. I was one of these "super" bears and had my views reinforced each month thru the regular monthly EW reports.
I think it is a good time to review my education in Elliott Wave Theory starting in 1995 with my reading of Robert Prechter’s great prophetic book At the Crest of the Tidal Wave. The charts and text in this book completely changed the rest of my life to date and I still recommend that the revised 1997 edition be read by all serious investors. Prechter’s 2002 book Conquer the Crash is an important sequel to "At the Crest" as it explains the wave five extension that delayed the year 2000 top.
The past 13 month rally has been a vivid example of the most important fact about Elliott Waves. This theory is all about Wave Forms and not about the Time to complete them. The theory gives important information about the direction of the next big move but the change will not begin until the completion of a wave meeting all the rules for valid Elliott Waves.
We are now in a huge bearish wave designated as Grand SuperCycle Wave !V which is now 4 years old and may last for many decades. Wave I in this Grand SuperCycle started in London about1700 and ended at the peak of the South Sea Bubble in 1722. Bearish Wave II ran from 1722 to 1784, or 62 years. Since waves II and IV of a five wave impulse cycle are usually about the same length, the current bear market may last for at least another 60 years. Of course only a tiny fraction of our population has this important information. Only our youngest readers may be here to welcome the next great bull market, Grand SuperCycle Wave V, which will end a huge five century Elliott Wave market cycle.
There is no tenable half way position. You either follow the Elliot Wave Theory or something else. However, it is possible to be aware of and accept the predictions of the Elliott Waves without pretending to be or becoming a serious expert.
A SPLIT ASSET PORTFOLIO FOR SERIOUS INVESTORS
We’re going to try a new approach by splitting ten funds into safe and volatile classes to emphasize the diverse strengths of the two sub-portfolios. And we are going to start with $100,000 to interest seasoned investors in giving it a try.
Stable Portfolio
$10,500 U.S. Treasury Intermediate Bond fund
10,500 Hussman Total Return fund (unique)
10,500 Foreign Govt.short/intermediate Bond fund
10,500 PSAFX "
" "
+ gold shares (unique)
10,500 Hussman Strategic Growth Fund (unique)
$52,500
Volatile Portfolio
$ 9,500 Prudent Bear short stock fund + gold shares (unique)
9,500 RYJUX short 30 year bond fund (unique)
9,500 Short S&P500 stocks fund
9,500 ASA (NYSE) Precious Metals Closed end fund
9,500 High Performing Precious Metals fund
$47,500
The stable portfolio will no doubt be a rather dull, but steadily growing portfolio that can be viewed monthly if you wish. It will sort of be like watching grass grow.
The volatile portfolio may have a few quiet periods but it will almost always be going either up or down. It will be a wonderful opportunity to learn about short funds and precious metals fund. Of course you do not need to have that much money involved unless you so desire. Over time, it should have some exciting gains and some losses. When losses exist at rebalancing time, there will be money transferred from the stable funds to rebuild the volatile funds and build future profits. There will also be large gains from both short and gold funds at their price peaks that will be transferred at rebalancing time to the stable reserve funds. This simple process, over time, will take substantial profits from all ten funds thru the magical process of systematic rebalancing.
THREE
YEAR PERFORMANCE DATA
Annualized Gain 11/21/00 - 11/28/03
Stable Portfolio:
U.S. Treasury Intermediate Bond
8.90%
Hussman Total Return
fund
8.94 *
Foreign Govt.short/intermediate
Bond 16.89
PSAFX "
" "
+ gold shares 15.07 **
Hussman Strategic
Growth Fund
19.32
Average Gain 13.82%
* From 9/18/02
**
" 1/02/01
Volatile Portfolio
Prudent Bear
short stock fund + gold 20.98%
RYJUX short 30
year bond fund
- 6.90 (1)
Short S&P500
stocks fund
5.27
ASA (NYSE)
Precious Metals fund
52.50
High Performing
Precious Metals fund 65.91
Average Gain 27.55%
(1) 27.34% since
6/13/03
Please note that two of the newer stable funds do not have data for the
full 3 year period. The average of the volatile portfolio uses the
negative 3 year RYJUX short bond performance although it has gained at
the annual rate of 27% since interest rates rose in June 2003. It should
continue to do well as interest rates rise.
The weighted average of 8 funds over more than 3 years and shorter periods for two others was 20.34%. Despite this excellent bear market return, there can be no guarantee for the future performance. During the past year the short funds had subnormal performance while the precious metals were outstanding, As in all of my recent essays, I strongly urge that all ten funds be rebalanced as a single portfolio at least every year and a day to take the long term gains that are available at that date in a taxable account.
In a tax free account one could choose to rebalance twice a year or at the price peaks of the short and gold funds whenever they occur. Be sure and see the examples of such rebalancing in previous essays. Regardless of when it is done or how frequently, rebalancing is extremely important to the success of our portfolio examples. It causes profits to be taken when they are available and retains the original portfolio composition balance.
DISCUSSION
There
are a limited number of asset classes that are useful in a bear market
and we have displayed all of them in portfolios of many sizes. This
seems to be an especially good time to build one since the bear trend
appears about to resume.
If any reader is troubled by a question that I can answer, I will be
glad to help. The truth is that, once a portfolio has been built,
there is very little management other than rebalancing. Over a period of
years, a particular fund may change its investment objective and
necessitate a change. Or a new fund may appear in one of the categories
which should be considered as a replacement for your portfolio.
We suggest that everyone get their financial affairs in good order and enjoy a successful and prosperous 2004. Best wishes for a happy Holiday Season
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© 2003 Robert B. Gordon, Sc.
D.
Dr,
Gordon's Editorial Archive
Robert
B. Gordon, Sc. D.
Sun City West, Arizona
November 29, 2003
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