No. of Recommendations: 26
Hank: I ran some very rough numbers of what would happen if one did 66.6% x and 33.3 % y in a market that took two successive hits of -30% each, followed by two successive "bursts" of +50% each. Rebalance to the xy percentages after each hit and each burst. No growth in the y portion counted....
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This is all very interesting. But using an arbitrary fixed allocation between stocks and cash/bonds is not a substitute for asset allocation or risk management. It's a fixed allocation, that's all. What I was advocating was to evaluate the relative value of each sector in order to determine whether a particular sector is over or under valued.

A simple application of that idea would be to do this. Compare the yield of cash to the SPX earnings yield. The SPX earnings yield is simply the ratio of estimated earnings for all stocks in SPX divided by the price of the index at that time. Use that in the denominator of a ratio, the numerator of which is the yield on cash, the proxy for which is the 3-mo tbill yield. When that ratio is over 1.25, reduce exposure to stocks. When it's under 0.75, increase exposure. How much you do of either depends on your personal risk perferences and how much you wish to avoid or embrace risk. Personally, I look for stocks to short when the ratio is too high and, conversely, buy stocks on margin when it gets too low. But I take more risk than most.

The above relative value ratio has actually had a gradually rising secular trend over the past 50+ years. So a more sophisticated application would be to do a regression of that trend over the past 50 or so years and measure deviations from the trend in std dev.

I mentioned this idea to a friend of mine recently, and he sent me a beautiful chart of this ratio covering the past several decades. For lack of graphics capability here I cannot post it, but I recommned that anyone interested in this idea calculate it and look at it for yourself. I have been using this idea for quite some time and have been quite pleased with it. Perhaps you will find it helpful too. It's certainly better than an arbitrary fixed allocation.

arezi
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