Alpha Power Investing Newsletter

January 29, 2010


The mid-cap index is largely ignored by investors, who tend to invest in the Russell 2000 index for small company stock exposure.

This is a big mistake. The mid-cap index has routinely outperformed the Russell 2000 and the S&P 500.

Standard and Poor's created the S&P Mid-Cap 400 index in 1981. The index encompasses 400 companies with market capitalization between $2 billion and $10 billion.

Stocks in this index are chosen based on market capitalization, liquidity, industry representation and profitability. When taken together, these stocks represent about 7% of total market capitalization.

The index is much less concentrated than the S&P 500. Although the index is cap-weighted, the top ten companies represent only 8% of the index, whereas the top companies in the S&P 500 can represent 30-40% of the index.

Since its inception 29 years ago, the S&P Mid-Cap 400 has compounded at 13.6% annually vs. 10.6% for the S&P 500 and 9.5% for the Russell 2000. Over the past 10 years, the mid-cap index has returned 6.35% annually, vs. -0.95% for the S&P 500 and 3.51% for the Russell 2000.

Over 10-year time periods, the S&P Mid-Cap 400 has outperformed 90% of diversified mutual funds.

That's why we use the Mid-Cap 400 index in constructing our favorite "power index".

The Alpha Mid-Cap Power Index is the mid-cap index held for seven months (November through May), then replaced by the intermediate treasury index for five months (June through October). The seven-month holding period exploits the annual "power zone" created by the forecasting industry in their yearly ritual of predictions for stocks, the market, the economy, etc. Because their predictions tend to be overly optimistic for the upcoming year, this six to seven month period normally results in a positive climate for the stock market. Since WWII, the returns of the stock market have been deeply "skewed" into this annual "power zone".

Click here to review the 29-year history of the Alpha Mid-Cap Power Index details as a PDF document.

Over the course of 29 years the Mid-Cap 400 has suffered 10 down periods during the "dead zone" (June 1 - October 31). A $1,000 investment in this five-month period is now worth $1,057, a rate of return close to zero. A $1,000 investment in the "power zone" (November 1 - May 31) is now worth $30,535, a 13.2% rate of return. As you can see, all of the aggregate return of the index has occurred in the seven month power zone. As a result, the Mid-Cap Power Index, which combines the "power zone" with conservative bond returns during the "dead zone" has surpassed the index by about 5% a year, with only one down year (1994) since 1981.

In summary, it's a simple strategy: take the best performing index, hold it during the "power zone" when the market climate is positive, and remain in bonds the rest of the time. Forget about earnings estimates, recessions, inflation, deflation, interest rates and all the other distractions of the investment world which are impossible for the human brain to consistently distill. Ignore fortune tellers, gurus, pundits, and the army of forecasting "experts". They are consistently wrong, overly optimistic and influential. Exploit them.

Jerry Minton, Ph.D.

Disclosure: Past performance is not a guarantee of future performance. No representation is made that the Mid-Cap Power Index represents the returns of any Alpha program or Alpha clients.

© 2010 Alpha Investment Management Inc.

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