O'Higgins Model Says, "Buy Stocks."

One of the most phenomenally successful investment models over the past several decades has been a model outlined in a book titled, "Beating the Dow With Bonds," by Michael B. O'Higgins. I used the word "phenomenally" to describe how successful it was and based on the results, I think you would agree "phenomenal" is not too strong a word to describe this success.

The table below shows the strategy of either investing in bonds or stocks and if bonds, short-term or long-term bonds. From 1972 through the end of 2003, $1,000 invested in the O'Higgins strategy would have grown to $426,709. By comparison, $1,000 invested in the Dow in 1972 would have grown to $34,824, dividends included. I would call that "phenomenal" wouldn't you?

The data through 1997 in the chart above was extracted from "Beating the Dow With Bonds." Since then your editor has updated this chart at the end of each calendar year except for the Dogs of the Dow performance. O'Higgins, who is the creator of "The Dogs of the Dow Theory" suggests in the book, that if his model gives a "buy" signal for stocks, you should, on the first business day of the year, simply buy the five worst-performing Dow stocks during the year that just ended. Since your editor was simply interested in the question of which is the better asset class to invest in between stocks and bonds, I did not update the Dogs of the Dow data from 1998 to the present.

To gain a full appreciation for the simple straightforward logic behind the "Beating the Dow With Bonds" strategy, subscribers are encouraged to by the book. But here are the mechanics of this process:

1. At the end of each calendar year, you buy a copy of "Barrons," from where you can gain the information you need to follow this O'Higgins model.
2. You find the 10-Year U.S. Treasury rate.
3. You look for the S&P 500 Earnings Yield (dividends paid plus retained earnings divided by the S&P 500 value).
4. You add 0.30% to the 10-Year U.S. Treasury yield.
5. You compare Treasuries + 0.3% with the S&P 500 Earnings Yield.
6. If the S&P 500 earnings yield is higher than the Treasury yield + 0.3%, you will invest in stocks for the entire year.
7. If the S&P 500 yield is lower than the 10-Year Treasury yield, you will invest in bonds.
8. If the gold price at the end of the year was lower than the gold price at the end of the prior year, you would buy the highest yielding zero coupon, U.S. Treasury bonds in the 20- to 30-year maturity range.
9. If the gold price at the end last year was higher than at the end of the prior year, then you buy one-year U.S. Treasuries.
10. You put your feet up and read a good book or go golfing. No need to worry about your investments. The total time to go through this exercise is not more than a half-hour each year. No newsletter subscriptions.

Just enjoy life and let the profits roll as they did for O'Higgins from 1974 through the present.

O'Higgins Is Now Saying, "Buy Stocks."

Although "Beating the Dow With Bonds" said you should only make the Treasury/S&P yield comparison once each year, I keep an eye on this measure each week. With earnings for the S&P 500 coming in quite strong and with long Treasury rates being so low, for the first time in many, many years, the O'Higgins model flashed a "buy stocks" sign on August 9. Clearly this presents a problem for our vision of an equity market that is poised for a major decline in the months and years to come. Given the outstanding success of the O'Higgins model, I do not take this new buy signal lightly. So how can we reconcile the contradiction with my view that stocks are "overpriced" and due for a major decline?

SECULAR GOLD BULL MARKET REMAINS IN PLACE

The average gold price so far in September 2004 is Average Gold Price-September 2004 = 406.95 Average 20-Month Moving Average = $380.71 Average 40-Month Moving Average = $340.71.

Where is gold going next? Roger Wiegand continues to target $502 by December 1. On the other hand, my friend Dave Morgan sent me an e-mail stating the following. "The pros (the bullion banks who hate gold most) have been shorting gold like crazy. I expect about 20 dollars to come off the gold price after the Republican convention-we saw 5 [dollars] of that today." In any event, as the chart above points out, gold remains in a powerful secular bull market.

September 7, 2004

Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com