FSO Editorials: The Real Bear Market Resumes by Robert B. Gordon 07/24/2004

The Real Bear Market Resumes
Where to Put Your Money for the Very Long Term
by Robert B. Gordon, Sc. D.
July 24, 2004

With the resumption of this vicious bear market, I have been doing some very long range thinking - 40 years of more. In this essay, I am not disavowing my previous suggestions, but supplementing them for the youngest segment of our readers. I hope they are of some value for all our readers, old and new.

Whether you have noticed it or not, dear reader, some of our favorites have lost their gaining ways. Over the last 6 months, the two Hussman funds and the Permanent Portfolio fund have registered annualized gains of about 1% or a little less. On the other hand, the Fidelity Food and Agriculture fund is gaining at 15% and PCL, our favorite timber stock, is gaining at an annualized rate of 17%.

The short funds are, in general, doing what they are supposed to do - gaining as the stock market drops. This is true of BEARX, a fully managed fund, and the reverse index funds RYURX and RYAIX. Personally, our own portfolios all have a very significant short position. We will continue to suggest short funds and hope that our readers will find how easy to own and profitable they can be in a serious bear market.

The major averages have completed the first of many waves 1 thru 5 down which will now become wave 1 down in a larger wave sequence. The Nasdaq is leading the way down right now. When wave 5 of this sequence is complete, these five waves will comprise wave 1 at a higher level and then waves 2 thru 5 will follow. There is a lot of room below for bear market progress. Please recall that the first major bear leg took more than two years before the first large rally began in March 2003.

Some years ago, Robert Prechter outlined his thoughts for Grand SuperCycle Wave IV which started at the 2000 market top. He suggested that, being a Wave IV, it would most likely take the form of multiple large up and down waves within a level price range similar to the smaller SuperCycle Wave IV that ranged from Dow 500 to 1000 for about 20 years in the 1960’s and 70’s. The twenty first century waves might range, he surmised, from Dow 500 to 11,000 and take the full century to complete. Yes, this sentence is correct.

Dear readers, how many people in the country are expecting a century-long bear market that slowly forms a series of high and low prices in the major indices. Virtually no one expects it and no one alive today will live to see its end. If it occurs, it will generate massive confusion in Wall Street and mass bewilderment among all but the few EW readers. I do understand it now because I was alive and investing during the last 20 year long "range bound" stock market in the1960’s and 1970’s. And I see ultra short wave IV horizontal triangles three times a week in my short EW reports. But my grandchildren will be the only possible beneficiaries of this family knowledge.

How low will the Dow eventually go? Below 500, Robert Prechter has said in writing on numerous occasions. Although this may sound crazy, it is based on historic evidence. Every market crash in history has eventually fallen below its starting level. In 1929, the Dow started at 100, rose to 390 and closed at 41 in 1932. This market started at about 500 in the mid 1970’s, rose to 11,700 in 2000 and is expected to eventually fall below 500. I will not see this market bottom but some of our readers may do so many years from today.

It has never been easy for individual investors to invest successfully for a full lifetime, although some major institutions have been able to do it for a century or more. So, regardless of how good or bad the future will be, investors will probably have their hands full if they expect to do well.

In my view, it is not possible to assume that most of our current mutual funds, or their sponsors, will be here in forty years. I expect the very large firms like Fidelity and Vanguard to be here but possibly with some unpredictable changes. I do expect the major stock exchanges to be here.

The mutual fund industry has spent huge amounts of advertising to convince investors to adopt a long term dollar cost average program for their retirement accounts. In the rare event in which the program starts at a market low and ends at a high, the program can be a success. But the chance of this happening for any large percentage of investors is almost certainly quite low.

In view of this problem, an astute investor should use a reliable method of depicting major tops and bottoms and then taking action to end the program at or near a top. We will describe one method for determining major market tops and bottoms.

An expert chart reader can readily set criteria for market tops and bottoms but how about an average investor? It is very simple and requires only a visit to one of several free on-line charting services. Put on the screen one of the many on-line S&P500 index funds such as VFINX and one of several reverse S&P500 short funds like RYURX. Over the last 4 years you will see opposing sets of peaks, positive for RYURX and valleys for VFINX. They are not rounded peaks, they are sharp parabolic peaks and valleys and both occur on the same dates as given below:

     04/04/01 - Modest High and Low Price Peaks
     09/21/01 - High and Low Price Peaks
     07/25/02 - Very High and Low Price Peaks
    10/08/02 -   "       "             "        "        "
     03/11/03 - High and Low Price Peaks

The place for portfolio action could easily be picked out from the chart by a small child or an adult with impaired reading. They are very easy to find, especially when both the two mirror images of the long and short S&P500 index are before you.

We specially urge every reader to repeat the above exercise right now for their great benefit. Do not put it off. Seeing these two long and short price patterns for the great bear market to date should go into your memory for its great teaching value. It should change quite a few negative attitudes on the use of short funds in the years ahead. It should also decide a few daring souls, over the bear market, to adopt a plan to switch back and forth between an index fund and its reverse index fund at the appropriate times. It can be extremely profitable even though boring because of the lack of trading activity. And for the more daring, remember there is a 200% negative S&P500 short fund to double the profits.

Before leaving this important subject, I must report on what has been happening for the past 5 1/2 months. Both the long and short curves show a long flat trading range of indecision in the market from mid January to the end of June - 5 1/2 months. The only similar period on the bear market chart to date was 4 months from mid November 2001 to mid March 2002, just before a large decline which led to a major bear market low. We now know from the EW status that a new bear leg is underway and slowly gathering momentum. One view of this is that the leg now starting may be the largest so far in this bear market. It would seem that the best action right now is to assume the worst until the present market picture improves substantially.

Although peering 40 years ahead is a thankless task, something useful may result from the discussion. I visualize this portfolio as a dollar-cost-averaging portfolio lasting about 40 years and then a withdrawal program for the retirement years. After putting myself in the place of this young investor and cogitating for awhile, I came up with a decision that surprised myself. I decided to suggest a program without ordinary mutual funds and to recommend purchasing only a highly select group of 4 Stocks and 3 closed end funds, so this portfolio would be completely free of the complete demise of the present fund industry if it were to occur. Please know that I am not predicting any such disaster, but I do intend to cite the large advantages of my 7 selections in five major areas for investing.

It is my considered opinion that a very long term investment program consisting of dollar-cost-averaging broadly in precious metals, real estate, oil and energy, timber and water will build capital in up markets and down, decade after decade. I believe that the average cost will be significantly below the prices prevailing at the end of the program. It is extremely important that the investing phase be ended as near to a high point in the stock market as possible. At that point it will be necessary to place all the funds in stable vehicles that will guard the purchasing power of the assets. This is extremely important. Consider any funds like the hedged Hussman funds if they are available.

As I have communicated some time ago, I have sold all my gold funds and stocks in line with Prechters bearish recommendations. It has been quite unpopular with a few readers who do not understand or appreciate the EW laws as I do. However, for a young investor just starting out, I see nothing wrong with commencing a long term gold accumulation program. And I plan to re buy gold and silver eventually whether Prechter is proven right or wrong.

Precious Metals
9% Newmont Mining -Very Large Co. NYSE
9% ASA closed end gold fund NYSE
9% CEF gold/silver bullion closed end AMEX
27% Total Gold and Silver

The three precious metals suggestions really cover the whole field quite adequately. NEM is the mining industry leader and very acquisition minded. The two closed end funds are favored because their price can be below NAV much of the time.

Petroleum and Resources is a very old closed end fund holding mainly energy companies with a minor position in electric utilities. It normally trades at a small discount to its net asset value on the NYSE.

Boston Office Properties is a national developer, owner and renter of prime office properties whose price may fall near term for reasonable periodic acquisition and hopefully rise in better economic times.

We have discussed PCL and WTR in recent essays and feel they have a bright future, long term, and may offer attractive buying prices in depressed markets ahead.

Before proceeding, we should add that we like the above 7 areas for continued investment at any age. These 7 areas, other than the precious metals, are not being touted by Wall Street or your daily newspaper. Purchased over time, the eventual returns should be very high when compared to the average cost from periodic long term buying.

Assuming this man or woman has liquid assets and is looking where to place them, we are suggesting placing them with Fidelity, Vanguard or both. These very large firms are the nation’s largest and almost certainly the most secure in any difficult future environment that may develop. Over the past 50 years I have owned dozens of funds offered by these firms and have a high opinion of their managements but not for all of their funds. However I can recommend a conservative fund pair from each firm, one with modest growth and the other for income and growth. Here are their16 year performance records from my FastTrack tm charts.

Fund	Avg. Annual Return 1988 - 2004	Morningstar Category	Stars
Fidelity Puritan	10.7%	Moderate Allocation	4
Fidelity Food & Agriculture	13.4%	Large Value	5
Vanguard Windsor	10.5%	Conservative Allocation	5
Vanguard Explorer	11.5%	Small Growth	4

I have probably owned all of these funds at some time in the past 20 years. Two have 5 stars the others 4. I picked them for safety over the long run, considering their performance was very reliable and satisfactory. Three of these funds are quite large and the best performer is quite small. It may have surprising growth as many other funds have huge redemptions in this bear market. Funds that are actually gaining will be in demand.

I recommend that anyone interested in buying these funds, singly or in a group, go to the Morningstar web site and read the full information available. In my opinion, investors should consider buying either the 2 Fidelity or the 2 Vanguard funds or all 4 funds as a package. The reason being is to give some variety to make periodic rebalancing profitable. New readers should go back in the Gordon archives in FSO and read how to rebalance and the great advantages of so doing with a disparate portfolio.

Whether an investor is involved with building either the 7 position portfolio or the 4 position fund portfolio or any combination thereof, they will all benefit from periodic rebalancing. The larger portfolio will build for several years without rebalancing but will eventually benefit greatly because the asset classes are quite different. This will not only increase the profits but will keep the portfolio within the desired percentages.

The 4 fund portfolio has a smaller volatility difference between its funds but will also benefit from an occasional rebalancing to keep the portfolio as originally planned. Although each of these funds does "march to its own drummer" I do suggest using equal quantities of the four funds, at least at the start.

Sooner or later many of our readers will at least do some experimenting with small quantities of short funds. It is really the surest way to pep up a losing bear market portfolio. Start with RYURX which is the least volatile of the group and then move up to RYAIX which has a little more zip. Serious investors should consider the 200% inverse funds RYTPX or RYVNX which can reap huge profits in down markets.

At some point in this bear market, millions of American investors will finally decide to sell all or a great part of their fund holdings. The timing is unpredictable but it will surely happen as it has in the past. Large funds will be decimated and small funds may be forced to close since they cannot stay in business with inadequate income resources.

An example of a small fund family is that of the Capital Preservation fund. It consists of 3 or 4 funds with nearly all the money in just the one pioneer fund. If that fund suffers a 50% redemption, there may be insufficient total income to support the overall business. Problems such as this will require close reading of any mail from the funds you own. Now the liquidation of a fund company does not necessarily mean any loss of your money but any trouble at a fund company may effect the performance of the funds you own. As this bear market progresses, you cannot afford to discard the fund mailings. Read them all.

Friday’s decline in gold brought an end to wave 2 up and was a start for wave 3 down. According to Friday’s EW report, gold is now headed down with no logical support above 350 dollars an ounce. I can almost hear the bulls wailing to me thru my computer screen

Since all of my gold was sold at higher prices, I intend to commence buying small quantities at prices below 350 dollars. This could be the last big opportunity to accumulate the precious metals.

Please send any questions you have from this or previous essays. I have finally sent in my 2003 tax report and have plenty of time to respond to your mail. I enclose a quote from John Hussman’s weekly report for this week. I agree with his words on sailing but he is dead wrong on investing. Ralph Elliott found the truth 70 plus years ago.

"Investing is a lot like sailing – you can go anywhere you wish without forecasting the wind. What is essential is to measure the wind properly and often, and align yourself with prevailing conditions.

That's not a suitable perspective for investors who want the certainty of knowing where the market is headed over the coming quarter or year (the subject of tireless discussion on the financial channels). But that's a certainty that can never be attained, and would turn thinking, breathing, active investors into dull spectators anyway. Life is in the living – the day to day uncertainty is part of the adventure."