FSO Editorials: Memorial Day Investor Review by Robert B. Gordon 05/31/2004

I am going to summarize some important points that may have been lost in the details of my recent essays. It may be a surprise to some readers to learn that I didn’t have all the background information and portfolio examples when I started to write in the fall of 2001. My early essays were warnings of what was to come in the stock market and economy. This was followed by a series of informative essays featuring important classes such as gold funds, short funds, and foreign government bond funds.

These subjects were followed by more essays on the economy and mutual funds in general. They were then followed by essays which suggested some early ideas on how to assemble a bear market portfolio. During this period, I was reviewing the past performance of hundreds of mutual funds to determine which few were the very best candidates for survival in a long and severe bear market. The funds were classified as stable or volatile and I began to present portfolio examples in my essays. During this period, I was also using these candidates in a number of real portfolios in order to compare current market behavior with that of the past 3 or 4 years.

Based on my total experience up to that time, I recommended that conservative portfolios needed at least 50% of the total assets to form a safe base for most investors. The other part of up to 50% was to be made up of volatile assets like precious metals, oil and gas, timber etc. plus one or more short funds for aggressive investors. I also provided examples with up to 80 or 90% of stable assets for conservative investors.

When the U.S. dollar began to weaken on the international market, I suggested short-term foreign government bonds should be used in an equal amount to any U.S. Treasury bonds. Then when the specter of higher U.S. interest rates arose, I dropped U.S. bond funds in favor of the Hussman Total Return fund. We also added the Hussman Strategic Growth fund. Both of these funds could use index hedges to protect their assets and had a large advantage over competitive funds.

Next we introduced an old favorite, the Permanent Portfolio fund with a fine 33-year performance record. It has a fixed portfolio containing 6 different asset classes. But we decided to put it into a new asset class for funds which are stable over the long-term. We then described several other funds and one stock that belong in this class and are suited to long-term portfolios.

The above summary has come from my imperfect memory only and is to provide some background for what I want to say to my readers on this Memorial Day.

In many of my essays I have commented on the vicious bear market that lies ahead, but let us review again what has happened in the past 4 plus years. In the first phase, trillions of dollars were lost in the severe initial drop that took about two years and ended in March of 2003. Then, a large bear rally retraced about half of the initial drop and ended in March or April of 2004. The size and scope of this great bear market is revealed by the fact that in the first month of the second wave down, the major averages have yet to drop 10%. Nearly all investors and advisors believe we are in a new bull market. They are making a huge mistake that will cost them dearly.

If any reader truly doubts the depth in percentage loss of the major averages and the length in decades (not years) that lies ahead, they should read or reread some of my old essays. This bear has already lasted nearly twice as long as any other in our history and is very likely to exceed the 14-year Japanese bear market and depression still underway.

Although I succeeded in getting thru the 1973-74 bear market without harm, that experience did not prepare me in any serious way for this bear market. It taught me to take it very seriously, but did not tell me what I should do to protect my assets. I have learned that essential information by using the experimental methods I have used all my adult life. My efforts have revealed a very short list of stable assets, another short list of long-term stable assets and a larger list of volatile natural resource and short funds.

Using the available asset list, we have published some dozens of portfolios ranging from very conservative to fairly aggressive. We did not give these portfolios to be blindly copied by anyone. We have wanted, and still do want, each investor to build his or her own portfolio from the asset classes in our list.

Why is it important for you to pick your own portfolio candidates? Because your own assets will be involved at risk and you should not let anyone else make the choices for you. Please understand that for each portfolio example I used for illustration, there is an almost infinite number of variations that could be just right for some investor. Only you, the investor, can make that decision. If you have picked one of my portfolio suggestions, please review it in the light of this essay to see if it is really right for you. Or if you have not yet picked a portfolio, you will benefit by studying the examples in the very next sections.

Here is a starting portfolio concept, which we will use to demonstrate how it can be varied for an almost infinite number of investor needs. Let’s start with:

PERFORMANCE FROM 11/21/2001 TO 5/26/2004
Allocation	Percent	Fund	Weighted %
Stable Assets
Hussman Strategic Growth Fund	30%	16.3%	4.9%
Prudent Global Income fund	10%	15.7%	1.6%
Total	40%		6.5%
Long Term Stable Assets
Permanent Portfolio	40%	13.9%	5.6%
Volatile Assets
Prudent Bear Short Fund	12%	12.3%	1.5%
Rydex Short 30-Year Bond Fund	8%	-6.6%	-0.5%
Total	20%		1.0%
Portfolio Grand Total	100%	14.2%	13.1%

In my considered opinion this is a moderately conservative portfolio. Let’s say that the total of the stable asset plus 1/2 the long-term stable provides the realistic value of total stable. That gives us 40 plus 20 = 60% stable, which is well on the conservative side. The volatile total is 20% plus 20% or 40%, only 2/3 of the total stable which confirms we have a moderately stable portfolio.

What is the very important mission of the short funds? It is to protect the other 80% of your assets from unexpected adverse events. Although the Hussman fund is supposed to be 100% hedged from losses, if it were our money I would want a second layer of defense. But even more important, these two short funds will make very important gains in the next leg down in this bear market. The small quantity of these funds suggested above will not be a source of worry. Instead, the short funds will bring you sure profits and pleasure for the full length of the bear leg. Then, you should take these profits thru rebalancing and transfer them to your stable assets.

Now, there is another side to the short funds. In the next bear rally, they will lose some fraction of what they gained in the down leg. Do not despair. All is still good. At the top of the bear rally, you should rebalance again by transferring assets from stable to short. This means that on the next leg down your short assets will be greater and the down side short profits will be greater as a result of the asset transfer.

Anyone who has any doubts about how the short fund will work should run a simple experiment somewhat as follows:

Buy the smallest quantity of BEARX ($1,000 in a tax-free account). Hold it for the duration of the full bear cycle described above and witness the growth in your asset. In this bear market the down side profit will probably be twice the ensuing loss on the upside. But in a real portfolio, using rebalancing, there will be profits from both the down and up cycles.

Please remember that in a severe bear market, short funds are the only medium that is guaranteed to provide profits. Every portfolio of every investor should have at least a modest amount of short funds.

Although there are only 5 funds in this portfolio, there are 10 different asset classes since the Permanent Portfolio has 6 permanent classes: Gold, Silver, U.S. Treasury and Swiss bonds, plus natural resource and S&P 500 stocks. Gold is also held by Prudent Global Income and Prudent Bear funds. By varying the percentage of these five funds, it is possible to build a personal portfolio over a wide range of conservatism. We invite each of our readers to do just that. We suggest a minimum of 10% in any asset class, including the total of the short funds.

A very aggressive portfolio would hold 30% each of Hussman, Permanent and Short funds total and 10% of Prudent Global. A very conservative portfolio would hold 40% each of Hussman Growth and Permanent Portfolio and 10% of Prudent Global and Short funds.

If you plan to start a new portfolio over a period of time, I suggest that you purchase the stable assets first and then add the volatile assets. However, if you plan to build it by means of a dollar cost averaging accumulation plan, I suggest that you rotate your purchases over all five asset classes.

Please note that the Prudent Global Income and Permanent Portfolio plan hold sufficient bonds between them that the Hussman Total Return fund is not needed. However, it can be added if you wish in which case you should make reductions in one or both of the other funds.

At this writing, the Elliott Wave status of both gold and silver shows them in a corrective wave up to somewhat higher prices. This will be followed by another impulse wave down. When the down waves are completed, we will have an excellent buying opportunity. In the meantime, three of the funds mentioned above continue to hold gold: Permanent Portfolio, Prudent Global Income and Prudent Bear.

It is entirely up to our readers to decide whether they wish to hold their precious metals during the current decline in prices. I have sold much of mine and hope to repurchase at lower prices.

If any gold bugs out there do not like my position on gold, I suggest they do not write but keep their opinions to themselves.

Over the past few months, all sectors of the market have been creating a massive top formation. Its size is an indication of the enormity of this bear market, which is clearly the largest in the history of the world to date. It provides serious support for Robert Prechter’s vision of a bear market lasting the entire current century. If you have work to finish your bear market plan, now is clearly the time to do it. We wish you the best of future success.