Alpha Power Investing Newsletter

April 8, 2010

What Ifs - Origin of The FormulaTM

What if #1: What if you invested in the stock market from November through May only, using the mid-cap index, and held intermediate treasury bonds the rest of the time?

Answer: Since 1981 (the year the S&P MidCap 400 Index was created) your compound rate of return (gross of expenses) would have been 18.3% annually (as of 12/31/09). There was one down year - 1994, -6.7%. In 2008, you would have been up 1.7%, in 2009 up 21%.

Cause: The annual forecasting cycle, in which the "experts" begin predicting next year's earnings in November, continue to project unrealistic optimism until June, then begin to revise estimates downward. This raises investor expectations from November to June, thus "skewing" the market's positive monthly returns into the "power zone". The mid-cap sector of the market, being the best performing sector long-term, benefits most from this annual effect.

What if #2: What if you invested in the market for just 15 months every four years: the fourth quarter of the second year in the presidential term and the third year of the presidential term?

Answer: Over the past 50 years there have been 14 such periods, and the S&P 500 has averaged a 30.3% return, with no losing periods. Using NASDAQ, since its inception in 1961, there have been 12 such periods, generating an average return of 47.0%, with one losing period - 1986-87, -5.9%. The Dow Industrials have not experienced a loss during this period since 1931, with an average return of 25.5% (plus dividends).

Cause: The mid-term elections focus the political class on the next presidential election. As a result, the dominant party and all incumbents shift rhetorical gears, becoming more fiscally conservative and less aggressive in pushing controversial, society-altering legislation. The appearance of fiscal sobriety is reassuring to investors. Since 1931, the third year of the presidential term (the pre-election year) has generated about three times the average return of the other years in the cycle.

What if #3: What if you combined #1 and #2 into one "Formula"?

Answer: If you invested in the 15-month election cycle "power zone" with a portfolio split evenly between the S&P 500 and the NASDAQ 100, and invested in the remaining "power zone" months (November - May) using the S&P MidCap 400 Index, then sat out the remaining months (14 every four years) in a good bond fund, like the PIMCO Total Return Fund, you would have received a 20.3% annual return over the past 15 years, net of a 3% annual reduction for fees and expenses. You would have lost 8.4% in 2008, the only losing year. 2009 was up 24%, putting the strategy at a new high.

Warren Buffet once said that good investing is simple, but it's not easy. The FormulaTM is simple: Be in the market when investor expectations are likely to be rising due to well-defined, powerful, cyclical forces. Otherwise, stay out. The hard part is ignoring all the informational "noise" that promotes indecision.

Click here for a downloadable brochure on The FormulaTM

Jerry Minton, Ph.D.

Disclosure: Past performance is not a guarantee of future performance.

© 2010 Alpha Investment Management Inc.

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