Are You Ready for Wave 3 Down?
by Robert B. Gordon, Sc. D.

Standard measures of bullishness in our stock market are at an all-time high. American investors are wrong again as we near a major top - Elliott Wave 2 of a 5-wave sequence. Wave 1 down started in 2000 and ended in 2002. As we write, we are at or very close to the start of Wave 3 down, expected to take the market to a major new low some years in the future.

Fortunately, there is still time to get ready for the expected major, multi-year plunge in our stock market. In many of our past essays we have given portfolio examples showing how to use stable funds in combination with more volatile funds, working together, to take profits in a down market through periodic rebalancing of the portfolio to its original composition.

It is now time to put this process to work again, doing its magic to take periodic profits from a properly designed mix of stable and more volatile funds.

SELECTED STABLE FUNDS

In the several hundred of our essays now available in our archive at FSO, we have picked three very stable funds for our new bear market portfolio - the two skillfully managed Hussman funds HSGFX and HSTRX and the Permanent Portfolio fund PRPFX, with proven stability over it’s more than 30 years of history. With these 3 very stable funds, we feel quite safe using just 50% total of stable funds in our portfolio for the next wave down. This allows us to select an equal 50% of quite volatile funds to complete the portfolio.

SELECTED VOLATILE FUNDS

There are many excellent funds that could be chosen for this volatile portion of our portfolio. With the very stable funds chosen above, we could have chosen small holdings of five or even ten quite volatile funds to make up the other 50% of our portfolio. We leave this decision to our readers.

For this conservative portfolio example we will choose to use just 25% each of two volatile bear market funds, first BEARX, a short fund designed to make good gains in a long and deep WAVE 3 of this continuing bear market and an energy fund ICENX with a great three-year record from holding a portfolio of predominantly small size energy companies from around the world. So far this portfolio has done very well vs. the large blue chip companies. Of course readers may chose to use both types of energy fund in their portfolio.

A SAFE AND VERY SOUND PORTFOLIO FOR WAVE 3

We show our suggested 5-fund, stable and volatile portfolio below as one example. Because of the very stable history of our 3 stable funds, we feel that an equal 50% split will be quite satisfactory, provided the portfolio is rebalanced when either the stable or volatile funds require rebalancing.

There are many excellent funds that could be chosen for this volatile half of our portfolio. With the very stable funds chosen for half of the portfolio, we could select as many as five or ten volatile funds to make up the other half of our portfolio. A large portfolio might use as many as five or ten volatile funds, but for our purpose we will assume we are building a modest portfolio. Our readers can use any number of volatile funds they choose but we feel strongly that our suggested 50% for the volatile funds be held to that maximum figure.

REBALANCING THE PORTFOLIO

In a volatile market as Wave 3 will surely be, it is not possible to predict how often rebalancing will be required. My guess would be to rebalance when either asset class rises to 60 percent of the portfolio. In the long bear market we expect, investors will have to use experience and their best judgment as to when to do it. Additions of cash to bring the ratios back to 50% should always be considered as well as extracting profits.

In our FSO archive, readers will find many examples of portfolio rebalancing.

NOTE TO MY FAR FLUNG READERS

At my 90-plus years, this is almost surely my last essay. I want to express my gratitude to Mary Puplava for her great help over recent years. She has helped tremendously to make my essays more readable and useful. So, I will say goodbye and wish her many more productive years.

I have continued to enjoy notes from readers over the past year of illness and have tried to send answers when possible. Now that Wave 3 down of this bear market is upon us, I sincerely hope my far flung readers will be able to benefit from my many bear market essays.