DJIA - DDV Model Works; Forecasting T Bond Rate Is The Problem

2024-01-09 07:04:48 ET

Summary

• Over the last quarter, the DJIA price has been volatile due to changes in the Dividend Discount Value, which is strongly influenced by the 30-year T bond yield.
• October's rise in the 30-year T bond yield above 4.5% caused a substantial drop in the DDV and DJIA prices, but they have since recovered.
• The DDV model is effective, but accurately forecasting the DJIA dividend and the 30-year T bond yield remains challenging.

Over the past three months, the price of the DJIA has moved in line with changes in the two main vectors of its Dividend Discount Value ((DDV)) which has been particularly volatile. There has been no problem with the DDV model but rather my inability to correctly forecast the rapid changes in the 30-year T bond yield.

This article is a follow-up to my most recent article on Seeking Alpha: 'Sell The Rally'

After 15 years of the 30-year T bond yield being below 4.5% with changes under that level having no impact on the DDV, on September 21, 2023, the 30-year T bond yield broke above 4.5% and rose to 5.11% on October 19, 2023, pushing the DDV down to 32,717. On October 27, the actual DJIA closed at 32,418. By October 31, the 30-year T bond yield was still pushing the 5.09 level, the DDV had recovered to 32,884 and the DJIA price was back up to 33,053.

The rise in the 30-year T bond yield in the six weeks before the end of October stemmed from the difficulty of attracting sufficient auction buyers to refund the long end of the treasury market. At the end of October into the beginning of November, two things happened:

1. J. Powel indicated that the Fed was through with tightening and would hold the Fed Funds rate steady and lower it in 2024, provided inflation continued its current path.
2. Janet Yellen moved the Treasury funding from the long end of the bond market to bills.

The combination of these factors resulted in a very sharp drop in the 30-year T bond yield to under 4.5%.

Coupled with a modest increase in the DJIA dividend to a new record of $733.74, the DDV of the DJIA rose to a record 37,666. The price of the DJIA followed rapidly, and even overshot, to a new all-time high close of 37,715 on January 2, 2024.

As the price of the DJIA at 37,466 is 200 points below its DDV of 37,666 and the 30-year T bond yield at 4.20%, below the empirical minimum of 4.5%, the only vector in the DDV model that can change the DDV in the near term is the DJIA dividend.

The DJIA dividend payout ratio is 50.6% compared to the long-term average of 63% With earnings, at $1,450.36, recovering nicely from the earnings recession which happened between February 25, 2022, and October 27, 2023, from $1790.18 to 1,399.55, the DJIA dividend is considered secure with room to continue to rise modestly even without any further improvement in earnings.

The DDV model works.

The DDV model works as it should. The difficulty lies in one's ability to correctly forecast the direction and level of its two main vectors, the DJIA dividend and the 30-year T bond yield. Forecast correctly these two vectors, and there is a 97% probability of correctly forecasting the price of the DJIA.

The move from funding with bonds to bills has alleviated the immediate near-term problem. However, it merely kicks the problem down the road. The United States still faces massive and growing debts and a huge jump in interest payments. This keeps the yield curve inverted and credit restricted and still points to the risk of a recession in 2024.

Unless there is a change in government debt management, now over US$34 trillion, the 30-year T bond yield will again move above 4.5% and push down the DDV taking the DJIA price with it.

Should the 30-year T bond yield remain below 4.5% the DDV will be affected only by changes in the DJIA dividend that could rise by some 10% either through better earnings or by a continuation of the rise in the dividend payout ratio which stands at 50.6% compared to the long-term average of 63%. A 10% increase in the DDV would result in a similar percentage increase in the price of the DJIA to approximately 41,400.

I am convinced that the DDV model is extremely useful in determining where the value of the DJIA is today relative to its price. However, as always, the difficult part is forecasting its two main vectors, the DJIA dividend and the 30-year T bond yield, particularly their future.

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