Dividend Discount Value of the DJII at Record Level, Almost Double its Price.

Yesterday was a major tax payment date for U.S. companies. For the rest of the year the U.S. Treasury will be out of the market. The Santa Clause Rally can now get underway with particular vitality as there is a high probability that the recent pull-back is behind us.

It looks like a repetition of October’s market action when the DJII fell through the first half of the month only rally to new highs in the second half. Irrational pessimism and fear seem to have taken over in the last 6 trading days.

Market participants and commentators alike blame oil’s collapse on a falling world demand and economic activity rather than the culmination of years of steadily rising production in North America brought on by the high prices of the last decade. Perhaps high prices are really their own best cure.

This latest fall in the DJII and other equity markets has been accompanied by a renewed flight to the perceived security of U.S. T bonds with the 30 year bond closing last evening at 2.75%. Coupled with the yet a further rise last week in the dividend of the DJII to $388.70 and the dividend-discount value of the DJII has been propelled to an all-time record. In the past this has proven to be the best time to buy.

Shorter term Arithmetic Chart

Longer Term Log Chart

Further evidence of the attractiveness of the DJII can be seen in the following chart: 

At the close of the market yesterday the yield of the DJII was 2.41% which is 82.3% of the 2.75% yield of the U.S. 30 Year T Bond. This, it must be stressed, is on a pre-tax basis. On an after-tax basis at the marginal rates for equities and bonds the DJII yield is significantly above that of the T Bond.

Furthermore, the dividends of the DJII have risen. In part with higher earnings, but also as the payout ratio recovers from record lows.

As the outlook for inflation remains subdued and looking at the demand for US treasury Strips, long rates should not rise very much during the rest of this decade. It seems, therefore, that the gap between the dividend-discount value of the DJII and its price will be closed by the price of the DJII moving strongly up until equilibrium is achieved.