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Saturday, July 17, 2010

Quick Update of Dynamic Asset Allocation Model

The model still suggests an 80% allocation to equities in the current environment. Despite the contraction in the yield curve, the expansion of the earnings yield measure and corporate credit spreads added more than the narrowing in the yield curve took away.

On a fundamental basis, this allocation makes sense for entirely another reason. The dividend yield on the S&P 500, forgetting earnings for a moment, is just shy of 2%, so you are only giving up 1% on 10-year treasuries just there. Among those stocks that are actually paying dividends right now, the average yield is 2.54%. Further, these numbers are depressed by the fact that almost all financial stocks, normally payers of robust dividends, have pulled back over the past two years to pay virtually nothing. Case in point, JP Morgan Chase (JPM) was once a payer of a 4% dividend or better, but in order to preserve capital during the financial crisis it put that down to 0.5%.

With such a narrow differential between bonds and stocks in terms of income generation, it doesn't make long term sense to be heavily in bonds at the moment. From a trading perspective, it varies, but for those without sufficient cash to trade, it makes the most sense to be heavily in equities in the present situation.


  1. I am so happy to hear you say that, Does this make me forward thinking or just lazy? I'd like to think it's both.

  2. I would say that it is possible we are in conditions that are such that the historical bases of the model might not be relevant, but I doubt it. I am nervous about some of the choices of policymakers of late, but I still think the medium term outlook for stocks is better than it is for just about anything else.