Opinions and observations expressed on this blog reflect the authors' individual experiences and should not be construed to be financial advice. None of the members of this blog are licensed financial advisors. Please consult your own licensed financial advisor if you wish to act on any recommendations here.

Thursday, June 3, 2010

Dynamic Asset Allocation Model: May Update

I will continue to provide monthly updates for the dynamic asset allocation model I outlined in an earlier post because the only real way to see what a model is made of is to test it in real time. Let's see what happened in May.

Using monthly closing numbers for the S&P 500, Ten Year Treasury, 90-day T-Bill, and Aaa 10-year Corporate Bond, the model suggests a continued heavy weighting toward equities at the maximum of 80%. Now, of course it suggested 80% before the bottom fell out of the market last month too, but the interest rate measures are largely designed to suggest the relative economic value of stocks and bonds and not to forecast crises. 

Due to the fall in the S&P 500 and 10-year interest rates, the earnings yield measure improved noticeably. Corporate credit spreads widened, also putting upward pressure on the equity allocation. The one negative is that the yield curve noticeably flattened, virtually entirely a function of the fall in ten year interest rates. However, the overall composite score for the model on which the asset allocation is based reached one of its highest levels in the 1954-2010 period. In other words, if I let the model fluctuate up to 100% allocations in either stocks or bonds, it would be pretty damn close to 100%. 

Frankly, this makes sense given where interest rates are right now. Bonds simply are not attractive relative to stocks at these interest rates given the recovery in corporate earnings. In the short run, as a crisis play, they have made sense, but remaining in treasuries for too long will wipe out those gains because 3.3% long term rates are not going to stay.

Take it or leave it. This is not professional investment advice, but this approach continues to suggest a high weighting toward stocks.

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