FSO Editorials: One More Time With Feeling by Robert B. Gordon 06/10/2004

One More Time With Feeling
And A Few More "Wrinkles"
by Robert B. Gordon, Sc. D.
June 10, 2004

We have spent considerable time and effort in spelling out the great importance of asset classes in determining the success of any portfolio in a difficult bear market environment. In recent writing, we have defined four major asset classes as follows:

Our high standards for stable assets have restricted this group to short-term U.S. Treasury and Foreign government bonds and the hedged Hussman growth and income funds. All the funds in this class have prices that vary daily both up and down. Their stability is high relative to other classes. It is expected that any short-term price losses will be regained over time. The average price of three or four funds should be more stable than any single fund in this class.

We have created a second class of assets that are stable over a ten, twenty-year or longer period with modest price dips in between. They are OK for any investor with an appropriate time horizon and are a welcome addition to the limited stable class. In this class, we described 3 major fund classes recently plus a unique stock PCL, a REIT timber stock. To this group I wish to add another stock, American Water Co., WTR, on the NYSE. It is the largest publicly owned water company in the U.S. in an absolutely essential business. It will be here, paying dividends, for a very long time.

At this time, our list of volatile funds and stocks is limited to those in the natural resource industry such as oil and gas and precious metals. Investors with a moderate risk portfolio and long time-horizon might consider one or two of the stable assets over the long-term such as the conservative bond/stock funds.

Since in the next big bear market leg the short funds may be the only asset class gaining in price, we favor everyone owning at least ten or fifteen percent of a short fund like BEARX which has a fine long-term record. A small percentage of the Prudent Bear fund in all portfolios will, in our opinion, be both profitable and educational.

We have been giving sample portfolios to illustrate how they should be built. In order to help investors get a start, we have published some with as few and 3 or 4 funds. This is great for a small starting portfolio, but should be increased for greater safety over an uncertain future.

We urge everyone to study our examples, but build their own portfolio. We have been encouraged by seeing a number of fine portfolios sent to us by readers. We are sure every investor will take more interest in his or her own portfolio than in one of ours.

In the three portfolios described below, we have given the bear market performance data starting on 6/8/2001, the earliest date for which data is available on the Hussman Growth Fund. This provides a full three years of bear market performance, both up and down.

CONSERVATIVELY AGGRESSIVE PORTFOLIO Performance from 06/08/2001 to 06/09/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth	25%	15.6%	3.9%
Prudent Global Income*	20%	14.6%	2.9%
Total Stable	45%		6.8%
Long-Term Stable Assets
Permanent Portfolio	10%	11.4%	1.1%
WTR (NYSE)	10%	12.8%	1.3%
Total Long-Term Stable	20%		2.4%
Volatile Assets
Oil/Gas Income Trust	8%	26.6%	2.1%
ASA Gold Stock (NYSE)	7%	23.8%	1.7%
Total Volatile	15%		3.8%
Short Funds
Prudent Bear Short Fund*	12%	15.9%	1.9%
Rydex Short 30-Yr Bond Fund	8%	-6.7%	-0.5%
Total Short Funds	20%		1.4%
Portfolio Grand Total	100%	14.2%	14.4%
* Holds Gold

As we did in the last essay, we will add half of the long-term stable percentage to the 45% stable for a total of 55%, leaving 45% for the volatile and short components. We consider this a moderately aggressive portfolio, which should do very well with excellent rebalancing.

CONSERVATIVELY MODERATE PORTFOLIO Performance from 06/08/2001 to 06/09/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth	25%	15.6%	3.9%
Prudent Global Income*	25%	14.6%	3.6%
Total Stable	50%		7.5%
Long-Term Stable Assets
Permanent Portfolio*	15%	11.4%	1.7%
WTR (NYSE)	10%	12.8%	1.3%
Total Long-Term Stable	25%		3.0%
Volatile Assets
Oil/Gas Income Trust	5%	26.6%	1.3%
ASA Gold Stock (NYSE)	5%	23.8%	1.2%
Total Volatile	10%		2.5%
Short Funds
Prudent Bear Short Fund*	9%	15.9%	1.4%
Rydex Short 30-Yr Bond Fund	6%	-6.7%	-0.4%
Total Short Funds	15%		1.0%
Portfolio Grand Total	100%	14.2%	14.0%
* Holds Gold

This portfolio, using the same rule as above, has 62.5% of stable assets and 37.5% of volatile assets. It also will benefit from periodic rebalancing actions.

CONSERVATIVELY LONG-TERM GROWTH PORTFOLIO Performance from 11/21/2001 to 06/09/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth	20%	15.6%	3.1%
Hussman Total Return*	15%	6.3%**	0.9%
Prudent Global Income*	15%	14.6%	2.2%
Total Stable	50%		6.2%
Long-Term Stable Assets
Permanent Portfolio*	10%	11.4%	1.1%
WTR (NYSE)	10%	12.8%	1.3%
PCL Timber (NYSE)	10%	11.5%	1.1%
Total Long-Term Stable	30%		3.5%
Volatile Assets
Oil/Gas Income Trust	5%	26.6%	1.3%
ASA Gold Stock (NYSE)	5%	23.8%	1.2%
Total Volatile	10%		2.5%
Short Funds
Prudent Bear Short Fund*	5%	15.9%	0.8%
Rydex Short 30-Yr Bond Fund	5%	-6.7%	-0.3%
Total Short Funds	10%		0.5%
Portfolio Grand Total	100%	14.2%	12.7%
* Holds Gold ** from 8/18/2002

This ten fund portfolio is very well diversified with 65% stable assets and 35% volatile using the same rule as above. It would be suitable for an investor with a 30-year time horizon. It will probably need rebalancing every 2 or 3 years, depending on the market action.

I cannot over emphasize the need for, and the great benefits of, rebalancing. Even the most conservative portfolio with no volatile asset classes should be rebalanced occasionally to retain the original proportions. Any portfolio with a significant amount of volatile or short asset classes requires rebalancing at least every year and a day in a taxable account or more frequently at price peaks and valleys in a tax-free account. This will add materially to the return.

The benefits are modest at first, but over a ten-year period will be surprisingly large. So, do not expect too much at first since the extra gains will eventually come from price volatility. Rebalancing near volatile price peaks will always lead to the best portfolio gains.

There can be no guarantee on future performance, but the performance data represents three years of bear market ups and downs, which make a good proving ground. Where an individual stock or fund has a longer history, I have reviewed their charts back to 1989. I have convinced myself that these securities are representative members of their respective asset class. I either own or have owned all of the securities mentioned except for WTR, which is my latest discovery and not really suited for an octogenarian.

Any single security in the portfolio examples, including the most stable, may have a temporary individual price drop for unknown reasons. After a year or two of experience, you will develop the ability to tell whether a price change either up or down has any significance. A portfolio holding 8 or 10 really different assets classes will always be more stable than smaller portfolios. For portfolios involving significant amounts of money, I suggest including every fund or stock known to be a good representative of its asset class. A large, well diversified portfolio will require little or no more management and will have fewer price swings and surprises.

Over a period of twenty or more years, it would not be surprising to have to replace a fund, which was merged or changed in objective. Of course, one of the stocks could also be acquired or merged. It is certainly not something to worry about now, since if it were to happen the manager would by then be a very experienced investor and know exactly what to do.

Believe it or not, although you would never suspect it by tuning in CNBC, we are in a huge, long bear market. The day to day movements are both up and down in price and sometimes the direction is difficult to discern. The Elliott Wave pattern is slowly disclosing the form of a declining bear market, with wave 1 complete and wave 2 nearly complete. Once wave 3 down gets underway, the downward pace will be more easily discernable.

The temporary indecision in the market in recent weeks has given all investors a good chance to make needed changes in their portfolios. If you are not ready for the next major wave down, please take action right now to save yourself from unnecessary losses.

Please do not fall for the bull market propaganda of Wall Street salesmen and mutual funds. Remember, their jobs depend on constantly giving their standard sales pitch. Although I do not expect to be here at the ultimate market bottom, I believe that most of the sales types will be unemployed or in different jobs. This certainly was true in the 1930s.

Your condolence notes were appreciated. Please send me your questions and I will do my best to answer them. Remember that I can only give general advice, not specific. Be prepared for a once in a lifetime experience as this bear market develops. There is still time to get your bullish relatives and friends to sell their risky stocks and bonds. Those who remain bullish will pay a heavy price as the market drops to surprisingly low levels.