FSO Editorials: The Great Bear Market is Back With a Vengeance by Robert B. Gordon 08/08/2004

The Great Bear Market is Back With a Vengeance
Upgrading an Old Favorite for Tough Days Ahead
by Robert B. Gordon, Sc. D.
August 8, 2004

This past week has brought some recognition -- at least to the bears -- that the tough times have started again. Although history tells us that the die-hard bulls will not admit it until much more damage has been done to their dreams of wealth. That is the way things have been in the past and the way they still are today. Millions of investors will hold on to their optimism for a long time as their market losses mount. They will not receive any advice to sell from their broker, their advisor or their mutual fund. Tragic losses will mount as the market continues its relentless decline.

Some months ago I rediscovered the thirty-year old fund proudly carrying the great name of the Permanent Portfolio. It has certainly lived up to its name and its six asset classes have survived a number of modest bear markets without major damage so far. It has proven to be quite stable in price, although its very modest growth record would not please many of today’s growth fund enthusiasts.

In recent months, we have added this fascinating fund to our long-term stable group and used it in quite a few portfolio examples. In this essay we intend to extend our previous efforts in an attempt to come up with portfolios that will satisfy a wider range of needs. We will start with a simple portfolio and build toward greater size and hopefully better adaptability to greater market fluctuations in the future.

Morningstar’s grading system couldn’t do justice to this one-of-a-kind treasure and finally gave it 4 stars in their conservative allocation group. But, in reality, it is truly a unique fund and head of its class of one. In its more than 30 years of existence, it has grown very slowly with little or no publicity and today has only about $125 million in assets.

Sell your losing stocks and mutual funds. Do it right now. Do not delay another day. This could be, and probably is, the most important message I have ever given in my 200 essays. In the 2001 and 2002 initial leg down in this decades-long bear market, many trillions of dollars were irretrievably lost by millions of American investors, mostly in mutual funds, who had engraved in their minds "do not sell - hold for the long term". Then, in the 12 month bear market rally that followed in 2003, investors were misled by ignorant advisors and eager sales people that a new bull market had begun. Nothing was further from the truth, it was simply a major bear rally that is now history.

In the meantime, many investors have continued with their long term buy program thinking it safe to resume their investing, again a very bad mistake. Now, for everyone in one of the categories mentioned above, please do not compound your grave past mistakes by making them even worse, much worse. Do not delay for another day, the selling of all your old and new losing stocks and funds. Sell them immediately before your losses skyrocket again. Please do not continue to kid yourself as so many millions of others have. These are not just "paper" losses. They are not going to go away and, if you do not sell now, they will get larger, very much larger. So, for your future welfare and that of your family, do not delay another day.

This lesson is the most important by far of any that I have offered in my 200 earlier essays. Millions of lives in millions of families across our land will be devastated in the years ahead as this great bear market continues, perhaps for many decades as predicted by the Elliott Wave Theory. Your paper losses have only one way to go if not terminated right now. Up. Up and Up. Do not procrastinate. Regardless of the pain involved, do it now for the future of your family. Start a new page in your life. Wipe the old slate clean. In the years to come, you will recognize the day you closed out your losses as one of the brightest days in your life.

The 3 individuals who created this fund in the 1970s decided to combine 6 asset classes which have made it quite unique. In fact it is hard to find a fund that has half that number, typically stocks, bonds and cash. Here are the 6 components of Permanent Portfolio:

20%   Gold bullion
    5%   Silver bullion
10%   Swiss bonds
15%   Natural resource
15%   Aggressive Growth Stocks
35%   U.S. Treasury etc.
100%   Total

This fixed composition is maintained by frequent portfolio rebalancing throughout each year. When this portfolio was conceived, it is quite likely that no one was thinking about a market crash and depression greater than that of 1929. Our senior economists were saying then that it could not happen again. Of course they were greatly in error in such thinking as it is clearly happening today. So we have to be concerned about the 15% in aggressive stocks and the high ratio of U.S. vs. Swiss bonds.

Due to the fact that there were no short funds either existing or contemplated, no thought was given to protecting the portfolio from its 30% in fairly aggressive stocks. Since we are now in the midst of a severe bear market, my first suggestion for an addition to this portfolio would be a sufficient short fund content to cancel out any drop in the stock portion. So let’s add 25% of BEARX and reducing the other component by that amount.

		Annualized Gain 08/04/2000 to 08/06/2004	Weighted Gain 08/04/2000 to 08/06/2004
Permanent Portfolio	75%	10.7%	8.0%
Prudent Bear Fund	25%	19.2%	4.8%
Total	100%		12.8%

Please remember that this two fund portfolio has a total of 7 different asset classes. The addition of the Prudent Bear fund made a noticeable improvement in overall performance over this 4 year bear market experience. But a much larger increase will come from the many opportunities for rebalancing at every market bottom. The significant BEARX gains at each market bottom should be redistributed by portfolio rebalancing. Remember that it also holds a 20% gold position which will have considerable value when the gold price moves up.

This updated version of the Permanent Portfolio should be a very good holding for many of our readers. It is very simple but its 7 asset classes are well suited to the present bear market environment. It is suited to a wide group of investors over a wide age span. One further suggestion would be to raise the BEARX to perhaps as high as 35% to compensate for its 20% gold position. This would drop the Prudent Portfolio to 65% and would mean a 28% short position which will improve profits without much more volatility.

For younger or more aggressive minded investors, I might suggest the addition of a few more asset classes to give it more growth potential over the next few decades. We will still use Permanent Portfolio as the largest segment of the portfolio:

		Annualized Gain 08/04/2000 to 08/06/2004	Weighted Gain 08/04/2000 to 08/06/2004
Long-Term Stable Assets
50%	Permanent Portfolio	10.7%	5.3%
5%	Food/Agric. Fund	6.0%	0.3%
5%	Defense/Aero Fund	9.1%	0.5%
5%	Lg. Water Co. Stock	16.4%	0.8%
5%	Lg. Timber REIT Stock	12.1%	0.6%
70%	Long-Term Stable		7.5%
Short Fund Assets
30%	Prudent Bear Fund	19.2%	5.8%
100%	Total		13.3%

It would be difficult to find 10 asset classes with greater diversification or future growth potential in my opinion. If I were several decades younger, I would be very happy to own this portfolio and rebalance it at every major market top or bottom to maximize the performance of Prudent Bear. Eventually the 4 minor growth stocks would contribute to the gains during rebalancing. From the very start, the large position in the Permanent Portfolio would provide an important stable reserve in each of the rebalancing actions. I highly recommend this interesting portfolio for your serious consideration.

For our younger readers with plenty of investing time ahead, I suggest that they start with their current assets invested in the 75/25 proportion of Permanent Portfolio and Prudent Bear funds as in Portfolio No.1 and then add the smaller amounts of the other four funds and stocks by dollar cost averaging over a period of at least ten and preferably 20 years. This will permit them to buy at lower average costs in the years ahead and will give them the ability to make any changes that may become available in future years.

The four added securities are our favorites for the foreseeable future and are expected to have unusually stable prices in what may prove to be very difficult times ahead.

We have been recommending them ever since discovering them from a reader’s suggestion in June of 2003. Until quite recently, they have performed according to their previous history and our expectations. Now, there are some doubts about the effectiveness of the hedging in the growth fund which totals 1.3 billion dollars in assets.

As of August 6, the Growth fund and the Income fund have had some slowing down in their growth rates, but nothing too alarming. To August 6, the Growth fund has gained 15.9% and the Income fund 7.3% from their start dates, which is not at all alarming.

The Income fund is recovering from its worst price drop of a few weeks ago that effected all similar bond funds. The growth fund appears to be heading into its worst price decline for no apparent reason other than Dr. Hussman missing the signs of the "market climate," which he reports on Mondays. In all of his writing, he has given no indication of knowledge about the Elliott Wave Theory. On last Monday, he reported the market climate was improving when the market was about to head straight down. It will be interesting to read his comments on the coming Monday. We can draw some comfort from the fact that Dr. Hussman reports all his savings go into the two funds monthly. That is some contrast to the reports of the mutual fund industry investigation ,which showed few managers had any of their money in the fund they managed. They should be barred from the industry!

I have had a drop-off in letters recently and urge you to send your questions as my health is fairly good and I have some time available. This is a good time to review your bear market investments because it will be a long time before we see the next bull market. In addition. every stock market in the world will soon be in a bear market for the very first time. This will surely bring on a world wide depression that will cramp the style of whomever is elected to our presidency. So please do not get so worked up over the election that you neglect your investments.

This is no time to be taking any undue risks with your money, but a time to be saving as much as you can for the hard times that are just ahead. I do not enjoy passing on this news, but I feel an obligation to do this as a warning to my far-flung reader group.

If you desire confirmation of my views on the economy, please read the many fine articles available on the following internet sites: financialsense.com, prudentbear.com, comstock.com, freebuck.com, fiendbear.com, safehaven.com. Remember, from reading FSO.com regularly, you are far better informed than 99% of those depending on their daily paper and TV. You can imagine what havoc lies ahead when the general public gets a small glimpse of the truth about the world economy and stock markets.

Please know that this new bear leg will surprise a lot of people, some in your family circle. Help them understand the seriousness of this bear market which will have a major effect on stocks and the economy over the whole developed world. It will not be over in a few months and will eventually effect every aspect of our economy. Our economists have made a huge mistake in predicting a recovery while the Elliott Wave theory was predicting a depression. Having lived through one major depression, I am confident of eventual recovery that may well make our country a better place to live. Do your part to make this happen.