FSO Editorials: It's Much Later Than You Think by Robert B. Gordon 12/10/2003

It's Much Later Than You Think
Message to Serious Readers in Their Fifties
by Robert B. Gordon, Sc. D.
December 10, 2003

Several weeks ago we addressed grandchildren in their twenties. We pointed out the many unknowns they would confront and urged them to commence a serious program of saving and investing to fund their retirement since there might be no other source.

In this piece we address their parents who are facing retirement much sooner and perhaps under very poor economic conditions. We have vivid memories of our own life in our fifties as it occurred during momentous times in the economy and stock market.

I made a major career change in 1970 when I was 55. I have a good memory of the economy and stock market of that time. After having spent 10 years developing high temperature alloys for jet engines and 22 years in R & D for nuclear power, the free world was filling up with jet planes and nuclear reactors. I elected early retirement and moved from California to Connecticut where I commuted daily to New York City at 14th street just above the crowded Wall Street area. Riding the subway each morning, I often saw familiar faces from the popular weekly Wall Street Week TV program. My work changed drastically from developing and producing new materials to setting up and managing the first Quality Assurance and Reliability department in the Electric Utility Industry.

The stock market had peaked with the DOW about 1000 in the Go-Go mini-mania of the mid 1960’s. Inflation and interest rates were rising to very high levels and setting up a severe bear market in 1973-74 where the major averages dropped about 50%. Using an un-weighted average of 3000 NYSE stocks showed that the broad stock market started down in early 1972 and dropped a whopping 63%. Many mutual funds fell 70% or more and there were net redemptions from funds for the next 9 years.

The bear market of the mid seventies was a major event at the time but pales to almost insignificance when compared to 1929 or 2000 in graphs using trading volumes divided by the national values of GDP at the time. And, please believe me when I say Wall Street was literally dead at the market bottom. It was not recognized as such until months later. Does our present market mania strike you as nearing a bottom like that? Also, there were net redemptions from mutual funds for at least the next nine years, or until1983. We have just had a huge dollar inflow into mutual funds in recent months. The crowd appears to be wrong again.

Please dear reader, read the last paragraph once more. Based on my experience in the Seventies, this bear market has not even started. We’re still in a huge Go-Go mania!

No one knows the answer at this time but, in its fourth year, it has now lasted longer than any U. S. bear market in the last 100 years. And, very important, extreme bullishness still pervades Wall Street and the general public. Price earnings ratios are still sky high. There has been minimal correction, if any, of the excesses of the previous market mania. Thanks to Alan Greenspan’s efforts, a huge housing bubble is still intact. Our public and private debt is at all time highs. All we need to complete the sad picture would be a terror attack.

As my readers know from past writing, the Elliott Wave picture holds nothing but very bad news. It explains, in believable long term charts, exactly why a severe, multi-decade bear market Wave IV is now in progress in the U.S. and other major economies. We have some reason to hope that our grandchildren will live to see the end of this bear market, but we have no basis for expecting the fifties generation to be alive at the bear’s end. Our current conclusion, therefore, is that this older group will have a less favorable economic time and greater difficulty in growing wealth for their retirement years.

If there are still any doubters of a long bear market, all they need do is look at the Japanese bear market that peaked in1989 at over 39,000 yen and has been well below 10,000 fourteen years later. Their serious combination of depression plus deflation has baffled this nation of people with a long habit of savings and investing managed by their women. Will a nation of spenders and borrowers do a better job? We’ll just have to wait and see what happens.

Alan Newman, a brilliant observer of this bear market, has just (12/3/03) published a remarkable illustrated article entitled METAMORPHOSIS. It is much too long and the illustrations are too good for me to attempt a summary. It can be read on the important www.fiendbear.com or www.safehaven.com web sites and I highly recommend that everyone, bull and bear, read it and think about what it says and means for your financial future.

I certainly do not enjoy bringing this message where the amounts of money are relatively large and professionally managed. But look at the sad state of billion dollar pension assets in control of our states and corporations. When stocks and bonds are both in bear markets, right now, there are few good choices for preserving large amounts of capital. And, if the money is a modest amount, and being managed, by a retail broker, the chances are quite good of losing capital due to being in the wrong asset class for this market environment.

Of course the housing boom is continuing and may do so for a while, but there is definite weakness in residential apartments and in commercial office space. It is inevitable in my view that the housing bubble will burst and spread to all types of real estate. An overall real property price collapse occurred to a great degree in Japan several years after their stock crash. We seem to be traveling along the same path a decade later.

I cannot divulge details from my reader e-mails, but I can assure you that I see some very poor investments caused by bad professional management and lack of knowledgeable supervision by the client. Unfortunately, lacking an advisory license, I am unable to help. I do my best to educate readers through my model portfolios but lack enough good investor feedback to judge their acceptance. I would appreciate any reader suggestions that would help improve this problem.

It is important for investors of any age to accept the need to update and modernize any inheritance that was first created in the last bull market. The chances are quite good that the portfolio holds securities that are unsuited for the current market. Many bonds, once of high quality, such as Ginny Mae’s etc., are now quite risky and should be sold. Continuing to hold older securities out of respect for the donor is quite unwise in this market climate.

The U.S. and other developed nations our now suffering the largest real estate bubble of all times. Every so-called expert in real estate mortgages, construction or sales is incredibly bullish at this time and vigorously denies the bubble even exists. But at the same time, experts in other fields are, from my studies, quite bearish on all kinds of real estate. One group has to be wrong and I will bet on the side of those who expect a major real estate disaster. Rental apartments and office rentals are already in deep trouble. I expect the pin that pricks the bubble will be a major rise in long interest rates that I judge to be inevitable.

If any reader has saleable real estate of any kind, my suggestion is to sell it and reinvest the proceeds in our recommended asset classes. There will be a wonderful time to acquire real estate at some time in the distant future. I also include many of the REIT mutual funds on my sale list due to the growing vacancies in apartment complexes and in retail store space. The experts in real estate are duplicating the same type of blindness to their bubble as did the stock investors in the mania up to year 2000. I believe the result will be very similar and will occur rather quickly once the bubble has burst.

This is not, in my opinion, a very good time to be optimistic about the twenty years ahead. Those who have been fortunate enough to have acquired substantial assets must be concerned about preserving them until they are needed. Many others still lack the assets required to take them safely through a lengthy retirement period. The first group needs more than capital preservation. They also need to preserve the purchasing value of their assets in a period of a declining dollar vs. foreign currencies.

Fortunately, using the right asset classes, it is possible to suggest portfolios for both groups, the haves and the have nots. Adapting these unconventional ideas, will not be easy for many individuals who are not fully aware of current dangers in conventional asset classes. We suggest reading a group of our recent essays to fully appreciate the hazards and how to avoid trouble by selecting asset classes that can do well in bear markets.

I know of nothing except precious metals that can fill this need over the long term. With essentially every nation using un-backed paper money as its currency and with plenty of paper and printing ink available, the future look pretty grim to me.

There is one major problem with precious metals - their incredible volatility that will test the nerves of even veteran investors. I have concluded that, for most investors, it is best to hold two separate asset classes (1) precious metals in coins and bars in very safe storage for long term possession and (2) precious metal stocks and mutual funds to be used for growth of capital in portfolios recommended in many of our recent rebalancing studies. Small holdings of gold and silver coins and bullion can be held in a bank safe deposit box or in a pipe buried in the back yard. Large holdings require a little more thought for their safety.

The future price levels of gold and silver in U.S. dollars are completely unknown at this writing. Robert Prechter’s book Conquer the Crash has just become available in a newly enlarged edition. It includes an up-to-date list of recommended places for purchase and storing of precious metals, provided certain minimum quantities are involved. We suggest that both gold and silver be considered for purchase because silver is greatly below its historic peak price. Silver’s only handicap is that it require much more storage space for the same dollar amount.

We are going to demonstrate two similar portfolios, using the same asset classes, which differ somewhat in growth potential and amount of management time required. From these two examples, an investor could easily design a portfolio with different levels of growth and safety to meet his or her needs. We are going to use familiar asset classes because we have no other acceptable candidates for a severe bear marker climate.

We will include eleven asset classes used in several previous essays and vary the ratio of stable to volatile asset classes so you will have the data to choose your own risk level. Our goal will be to maximize the growth potential while retaining an adequate, very conservative base to support an important rebalancing program. See previous essays for more details.

     6. Inverse 30 yr. U.S. Treasury bond fund.
     7. Inverse stock index short fund
     8. Inverse stock short fund with an added gold position
     9. Precious metal mutual fund
     10. Silver mining stock
     11. Natural Resource stocks or fund - gas, oil, coal, lumber

         BTTNX Zero Coup. Bond fund 2010           9.42%
         Foreign Govt.short/intermed.Bnd fund       16.09%
         PSAFX "       "          "    + gold shares    15.24%*
         Husssman Total Return Fund                    8.85%**
         Hussman Strategic Growth Fund              18.63%
                               Average Annualized Gain   13.65%
         * From 1/02/01, ** From 9/18/02

          Prudent Bear short stock fund + gold        18.97%
          RYJUX short 30 year bond fund               - 6.48% (1)
          Short NASDAQ index fund                          2.40%
          High Performing Precious Metals fund      62.03%
          Silver Mining stock NYSE                          60.00%
          Diversified Energy fund                               9.66%
                                Average Annualized Gain   24.43%
          (1) 28.20% since 6/13/03

Please note that, using the present 28.20%rate of gain in the short bond fund, the 3-year average annualized gain for the volatile portfolio rises to 30.2%. This is the actual current rate of gain but there is no assurance what it will be in the future. We would expect the precious metals funds to slow down from the last 3 years, while the short funds contribute more. The uncertainty can be interesting as long the overall portfolio is gaining. That is why the stable portfolio plays such an important role. It keeps a large part of your assets as a big stabilizing element that can shift money into the volatile assets at any time their price is depressed. This is the secret by which rebalancing continues to create future gains for every one of the asset classes over the long run. If any reader needs a better explanation, send me a question and I will try to help clarify it.

We selected the 2010 zero coupon bond fund because it will mature in 6 years and the funds can be reinvested in the 2015 or 2020 bond fund. To my knowledge there is no silver mining fund since most silver is produced as a byproduct of other metals. There are however several silver stocks to choose from. See a recent essay for a list of no-load fund companies with an energy fund. A number of internet sites publish current lists of gold funds, ranked by performance. You will have to search for them because I use my own software program for this purpose.

We have long recommended that, for safety, a portfolio needs to have at least 50% of safe asset classes with a high probability of not losing money. However, we realize that our readers have various goals and needs, so we’ll let them pick a portfolio in the range of 45 to 55% of stable classes and 55 to 45% of volatile classes. We will keep things simple by using equal dollars within the stable and volatile groups. Here they are for your examination.

STABLE ASSET CLASSES	100%	#1 - 55%	#2 - 45%
US Treas. Zero Coup. Bond Fund 2010	9.42%	5.18%	4.24%
Hussman Total Return Fund	8.85	4.87	3.98
Foreign Govt. Short/Intermed. Bond Fund	16.09	8.85	7.24
PSAFX Govt . Short/Intermed. Bond Fund + Gold Shares	15.24	8.38	6.86
Hussman Strategic Growth Fund	18.63	10.25	8.38
Average Stable Gain	13.65%	7.51%	6.14%

VOLATILE ASSET CLASSES	100%	#1 - 45%	#2 - 55%
Prudent Bear Short Stock Fund + Gold	18.97%	8.54%	10.43%
RYJUX Short 30-Year Bond Fund	-6.48 (1)	-2.92	-3.56
Short NASDAQ Index Fund	2.40	1.08	1.32
High Performing Precious Metals Fund	62.03	27.91	34.12
Silver Mining Stock NYSE	60.00	27.00	33.00
Diversified Energy Fund	9.66	4.35	5.31
Average Annualized Gain	24.43%	10.99%	13.44%

Total Portfolio Gain		18.50%	19.58%

Using the actual growth rate of RYJUX over the past 6 months, let's insert those values in the table above.

VOLATILE ASSET CLASSES	100%	#1 - 45%	#2 - 55%
Prudent Bear Short Stock Fund + Gold	18.97%	8.54%	10.43%
RYJUX Short 30-Year Bond Fund	28.20	12.69	15.51
Short NASDAQ Index Fund	2.40	1.08	1.32
High Performing Precious Metals Fund	62.03	27.91	34.12
Silver Mining Stock NYSE	60.00	27.00	33.00
Diversified Energy Fund	9.66	4.35	5.31
Average Annualized Gain	30.21%	13.59%	16.62%

Total Portfolio Gain		18.50%	19.58%

Portfolio Totals Corrected with Current Data
Stable Portfolio	55%	7.51%	Stable Portfolio	45%	6.10%
Volatile Portfolio	45%	13.59%	Volatile Portfolio	55%	16.62%
	Total	21.10%		Total	22.76%

The small difference in overall growth with the 10% change in composition, shown just above, was a pleasant surprise. My conclusion is that readers should feel free to choose an equal 50% of the stable and volatile components or any other ratio within the range we demonstrated. Let us go over the 11 asset classes and see how many really different classes we have. We use quite a small number of major classes but four of the five have sub classes which will perform differently and add to the potential for capital gains.

      Government Bond Asset Class
             U.S. Treasury Bonds
             Foreign Govt. Bonds
                   "         "          " with Gold
     Hedged Securities
             Income Fund
             Equity Fund
     Short Funds
             Short bond fund
             Short Index fund
             Short managed fund with gold
     Precious Metals Funds
              Gold fund
              Silver stock
     Diversified Energy Fund

In summary, we have 5 important Asset Classes, all but one of which have two or more sub-asset classes. Note that all 11 classes will "march to different drummers" in the stock market. This gives us plenty of opportunity for differential growth within 4 of the major asset classes. In conclusion, we suggest that a tax free account could start an exciting portfolio with $1,000 in each of the 11 sub classes, or a total of $5000 stable assets and $6000 in volatile assets. The ratio of stable to volatile would be .45.4 to, 54.5 which is just within the range that we investigated earlier in this essay.

Yes, selecting the right asset classes is most important at the start but, after the first year, periodic rebalancing, becomes much more important to the long term success of your portfolio.

So far, we have covered the 3 year returns of the 11 individual asset classes which are quite impressive. With periodic rebalancing, as explained in previous essays, the future results should be even better. But without rebalancing, the growth would eventually decline and become much more volatile and quite different from the original composition. Here we list the uniform values of the 11 asset classes on 12/01/00 and their values as of 12/3/03.

VALUES AT 12/3/2003 WITH AND WITHOUT REBALANCING
Stable Asset Classes	Start	Before Rebalanced	After Rebalanced
US Treas. Zero Coup. Bond Fund 2010	$1,000	$1,308	$1,872
Hussman Total Return Fund	$1,000	$1,288	$1,872
Foreign Govt. Short/Intermed. Bond Fund	$1,000	$1,561	$1,872
PSAFX Govt . Short/Intermed. Bond Fund + Gold Shares	$1,000	$1,529	$1,872
Hussman Strategic Growth Fund	$1,000	$1,665	$1,872
Sub Total	$5,000	$7,351	$9,360
VOLATILE ASSET CLASSES	Start	Before Rebalanced	After Rebalanced
Prudent Bear Short Stock Fund + Gold	$1,000	$1,679	$1,872
RYJUX Short 30-Year Bond Fund	$1,000	$ 825	$1,972
Short NASDAQ Index Fund	$1,000	$1,073	$1,872
High Performing Precious Metals Fund	$1,000	$4,251	$1,872
Silver Mining Stock NYSE	$1,000	$4,096	$1,872
Diversified Energy Fund	$1,000	$1,317	$1,872
Sub Total	$6,000	$13,241	$11,232

Total Portfolio	$11,000	$20,592	$20,592

It is quite obvious that this portfolio as of 12/3/03 is greatly out of balance due to the huge growth in the precious metals over the past 3 years. From our very first essay on this subject, we have always recommended rebalancing at least every year and a day in a taxable portfolio. In a tax-free portfolio, there were several price peaks where it would have been advantageous to rebalance. Looking at the FastTrack charts over the past 3 years, we see the following dates where it would have been a good idea to rebalance. These were:9/21/01 and 10/8/02 for the short NASDAQ fund and 5/24/02 and 1/24/03 for the precious metals fund. By not taking the profits in the short fund as indicated at the prior peaks, these profits were lost - they just evaporated rather than being transferred to the stable funds and retained in the portfolio. With precious metals at a new price peak as we write, rebalancing should be done immediately.

As shown in the final column, the gains in precious metals are reinvested in all nine of the other funds. This simple practice, done repeatedly over the years, turns temporary "paper" gains into permanent gains in the stable asset classes. Please write and ask for help if you have difficulty with this very simple process. Do not hesitate to question me because this is how ordinary investors can grow wealth safely. Because we did not rebalance earlier, the substantial temporary gains in the short funds were lost.

We know at this time exactly how these recommended asset classes have behaved in the past 3 bear market years. We have shown that this good performance exists over a reasonable range of stable vs. volatile components. No one can predict the future and I will not do that. But I will say that following a portfolio with these specially selected asset classes will provide a great wealth of very valuable market experience.

I hope that readers will accept this opportunity to start a serious growth program for whatever cause they choose. I encourage all readers who build their own portfolio to send the details to me and I will respond with my comments. Please do not worry about getting the very best fund for each class. It may not be best 6 months from now. The major and minor asset classes are what is important in every bear market And do not underestimate the great importance played by the stable asset classes. Start with the right initial balance between classes and rebalance as determined by the portfolio growth. You will only find out how simple it is by doing it. There is no better time than right now. Good luck to all.