FSO Editorials: 4 Simple, Effective Bear Market Portfolios by Robert B. Gordon 05/05/2004

Four Simple, Effective Bear Market Portfolios
For Investors of All Experience Levels
by Robert B. Gordon, Sc. D.
May 5, 2004

All sections of the stock market have been going down for several weeks in what is the initial phase of a huge price drop that will shock every investor. In Elliott Wave terms, we have completed Wave 1 down and are near the end of Wave 2 up. This will be followed by Wave 3 down which is normally the longest, then Wave 4 up followed by Wave 5 down. Waves, 1, 3, and 5 are made up of 5 smaller waves each and waves 2 and 4 consist of 3 waves each.

This wave structure, discovered 70 years ago by Ralph Elliott, is found in every market in the world, regardless of whether it is measured in minutes, hours, days or centuries. It is absolutely fundamental to understanding any kind of market. It is very strange and tragic that this extremely important knowledge has yet to penetrate our ivory tower economists who advise our Washington leaders on the economy. To my knowledge only one Chilean economist has written a paper on Elliott’s great work, but it is almost unknown to others. So our nation’s leaders are blindfolded as we move into a great national and world tragedy.

In our long search for mutual funds well-suited to a bear environment, we looked for funds suited for stability on one hand and controlled volatility on the other. We had already found the best short funds for our needs. We were very fortunate to discover a very small number of old favorites plus two newer funds with unusual features.

In recent months, I have presented and discussed quite a number of portfolios containing from as few as two funds for beginners to more then ten funds. All of the portfolios, except the very simplest, contained a balance between stable and volatile funds and some held one or more short funds. Each portfolio presented had been given a retrospective test over a number of prior bear market years.

This quite modest research program has given me a lot of fun and satisfaction since I have been relatively inactive in 24 years of retirement. My mind generates new ideas and I then test them, keeping the good ideas and rejecting the others. One good idea leads to another better one, so ultimately only the best ideas remain.

We were familiar with the introduction of the Permanent Portfolio Fund a little more than thirty years ago, but forgot about it until recently receiving a reader's note. I became very interested in it as a possible stable fund. Its record to date is simply amazing, with a curve on my computer screen that is quite smooth and gently rising. I placed it in the stable portion of a number of portfolios. With a deeper look at the assets that PRPFX holds, I have decided to move it into a new moderate volatile category. This unique fund holds 55% of volatile elements: 20% gold, 5% silver and 30% stocks which includes 15% natural resource and 15% S&P500 index stocks. This mix has never, in the previous 30-plus years had to undergo a real major bear market such as we are now entering. However, it will be very valuable if used correctly in one of several moderate balanced portfolios.

As my readers probably know, I typically publish new ideas as soon as I have tested them and found them to be useful. That is the case with this new family, featuring four unusually well-qualified funds. For quite some time, I have tended to favor portfolios containing from five to ten funds or more, feeling that the diversification would be useful in many ways. But I now think it possible to use just four funds, uniquely capable to work together. These simple portfolios are easy to build and easy to manage and can be started at modest cost.

We are using four funds, all with distinguished management in four portfolio examples, but any reader can easily select a unique composition of their own. The expected volatility of the four funds is first, BEARX, then PRPFX, HSGFX and last HSTRX.

PORTFOLIO 1 FROM 9/18/2002 TO 5/4/2004
Allocation	Percent	Fund	Weighted %
Stable
HSGFX	25%	24.8%	6.2%
HSTRX	25%	9.3%	2.4%
Volatile
PRPFX	25%	17.2%	4.3%
Short
BEARX	25%	-5.6%	-1.4%
Grand Total	100%	14.2%	11.5%

Since we have been in a bear market rally for over a year, the negative performance of BEARX will soon turn into a positive number. In fact, if this portfolio had been underway for several years, there should have been a rebalancing step that added money to BEARX near its price low. This rebalancing step would, of course, have led to greater profits in the coming down market.

Starting with equal amounts of the four funds, rebalancing will be very simple. Just divide the total value by four and then change each fund value to that figure. This portfolio has the highest amount of BEARX and should do best in down market phases.

PORTFOLIO 2 FROM 9/18/2002 TO 5/4/2004
Allocation	Percent	Fund	Weighted %
Stable
HSGFX	30%	24.8%	7.4%
HSTRX	20%	9.3%	1.9%
Volatile
PRPFX	30%	17.2%	5.2%
Short
BEARX	20%	-5.6%	-1.1
Grand Total	100%	14.2%	13.4%

It should be remembered that these results at the next market bottom will be quite different than shown here. BEARX will have large gains that should be distributed to the other funds via rebalancing. This asset transfer will improve the results in the next bear market rally.

PORTFOLIO 3 FROM 9/18/2002 TO 5/4/2004
Allocation	Percent	Fund	Weighted %
Stable
HSGFX	35%	24.8%	8.7%
HSTRX	25%	9.3%	2.3%
Volatile
PRPFX	20%	17.2%	3.4%
Short
BEARX	20%	-5.6%	-1.1%
Grand Total	100%	14.2%	13.3%

This portfolio has the largest amount of the Hussman funds and the smallest amount of PRPFX and BEARX. It should do best in up markets and poorest in down markets.

PORTFOLIO 4 FROM 9/18/2002 TO 5/4/2004
Allocation	Percent	Fund	Weighted %
Stable
HSGFX	30%	24.8%	7.4%
HSTRX	18%	9.3%	1.7%
Volatile
PRPFX	40%	17.2%	6.9%
Short
BEARX	12%	-5.6%	-0.7%
Grand Total	100%	14.2%	14.3%

There is a greater difference in these portfolios than you may see at first glance. For example, the amounts of PRPFX and BEARX cover a 2 to 1 range, while the two Hussman funds have a much more narrow range. It is not possible for me to guess which portfolio will do best over the next five years, but I am sure there will be differences. Since each portfolio can be created in a tax-free account for just a few thousand dollars, perhaps someone may choose to build two portfolios and have a contest to see which one will win. Please note the first 3 portfolios have either 50 or 60% of stable assets, while #4 has just 48% to make room for a greater amount of PRPFX which may be somewhat volatile at a future time although it has not been so in 33 years.

We have already had more than four years and only one down/up stock cycle has been completed. It is already the longest bear market in our history. But we have the example of Japan, which is now mired down in a 14 -year long bear market and depression. The picture we get from the Elliott wave history is not encouraging since the Grand SuperCycle Wave II in the 18th century lasted for 62 years. We are now in Wave IV which typically resembles the previous Wave II in length.

I wish I could be more optimistic, but I see no data to inspire optimism. It is absolutely imperative in my view that every family that reads this message takes the bad news seriously and prepares for a long siege. Gather and secure your resources and prepare for a difficult period ahead.

Please do as much as you can to help others in your circle of acquaintances. Right now the great majority of Americans are "sound asleep" to the problems ahead. They are busy enjoying their new home or new car or new something and are blissfully unaware of what is about to happen to our nation and world.

It may be a while before another essay is published on FSO. However, please keep your e-mails coming and I will try to answer them promptly. Be prepared for some big down days in the market and keep your spirits up.