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To: Tommaso who wrote (7267)	11/7/1997 8:08:00 AM
From: Defrocked	Read Replies (1) of 18056

A Simple Quantification of Current Risk/Reward Tradeoffs Subtitled: Nothing's this simple but its a logical place to start The following table is a simple attempt to quantify one subjective outlook for the stock and bond markets and compare their relative risk/reward tradeoffs. Five reasonable economic scenarios with their odds of occurrence and resulting 10 Yr. Treasury note and DJIA percentage changes are compared. Note that the Expected Value of holding 10 Yr.Notes is now 7.2% and greater than the 6.0% for the DJIA. Further note that prior to Aug. stocks had an EV outlook of 9.3% based on the odds assumed before the Asian declines. 10Yr. Treas. US Stocks Current Yield= 5.9% 1.8% Current Level= 100.00 7700.00 Economic Current Pre-Aug'97 Scenario Odds T-note %Chg DJIA %Chg. Odds 1 30.0% 0.0% 20.0% 35.0% 2 25.0% -5.0% 10.0% 35.0% 3 30.0% 4.5% -5.0% 20.0% 4 10.0% 7.0% -15.0% 5.0% 5 5.0% 10.0% -25.0% 5.0% Expected Value= 7.2% 6.0% 9.3% ES1 Continuation: Better than avg. growth,3.5%, with contd.low infl. ES2 Growth/Inflation: 3.0-4.0% Growth, Infl. returns, Fed tightens ES3 Mild Slowdown: 1.5-2.5% Growth, Infl.abates, Deficit expands ES4 Mild Recession: 1998 growth of 1% with 2 Qtrs. of neg.growth ES5 Severe Recession: 1998 growth of 0% with 2 Qtrs. of neg.growth Expected Value=sumproduct(scenario odds,% change) + yield Of course, anyone can set up a similar spreadsheet, incorporate different odds and outlooks and I encourage them to do so. Note that expanding the odds across the scenarios is representative of increasing uncertainty and volatility for the markets. IMHO many portfolio managers will revise their odds of recession upward slightly now and reduce the extent of a stock rally down a bit as was done here and come up with a similar conclusion: A reduction in the percentage of stocks held is prudent. In other words, the uncertainty of holding stocks, the slight increase in a recession and the larger increase in volatility may encourage further selling. BWDIK PS: The odds may now have to be updated to reflect greater slowdown possibilities.

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