401(k) WealthEngine News
December 2010

Investment Status: The 401(k) Formula^TM is fully invested in equities. The allocation is 50% Large Cap Growth and 50% Aggressive Growth. In our model, the Large Cap Growth component is represented by the S&P 500 index while the Aggressive Growth component is represented by the NASDAQ 100 index. Your 401(k) will have its own funds representing these two asset classes.

Investment Comments: The 401(k) Formula^TM adopts a fully-invested equity position for 20 months every four years. The first 15 months of this period is called the election cycle "power zone". The election cycle "power zone" begins in October of the mid-term election year (year two of the presidential term). This 15 month period has delivered above average returns, with no down years (Dow Industrials, with dividends) since 1931. Over the past 80 years, the Dow's average appreciation during the "power zone" has been close to 26%. Adding in dividends brings the average total return to about 30%.

In the modern era, since 1963, the third year of the election cycle stands head and shoulders above the other years in the cycle:

This data supports the claim that politics has a profound impact on the stock market, regardless of economic conditions. The mid-term elections mark a turning point in political rhetoric and behavior. Politicians turn their attention to the next presidential election and do everything in their power to convince the electorate that the economy (and national prosperity) is growing. The Federal Reserve normally attempts to expand the money supply and keep interest rates stable. Economic prosperity at election time is a virtual guarantee of re-election for incumbents.

This shift toward fiscal responsibility (even though it's short lived) encourages investors and promotes risk-taking behavior and higher stock prices.

As encouraging as this historical trend is, it remains a probability - not a certainty. There are no sure things in the investment equation, especially in the short term. But as Ben Graham (the father of securities analysis) said, "The market is a voting machine, not a weighing machine". What he meant was that emotional reactions of investors are the primary driving force in stock price changes, not long-term rational calculations. My hope is that investors are positively impacted by the regime change in Washington and remain emotionally upbeat for the next 12 months or so.

Long-term Strategy: The next ten years will be more challenging than the past decade. Part of the reason is that we won't be able to count on bonds delivering high returns due to capital appreciation. Short term rates are at zero, and the 10-year rate is at 3.5%. These conditions practically guarantee low bond returns in the future. These conditions may also cause the stock market to be more volatile as investors are pushed into taking more risk than normal in order to secure higher returns. This volatility should play into our hands due to our strategy's tactical nature.

Based on your age, you should be holding a portion of your 401(k) in conservative bonds as follows:

Remember, if you have any questions about your account or the strategy being employed, please call me to discuss your concerns.