A value based allocation strategy

I've mentioned my tactical asset allocation efforts in a couple of previous posts.  Both of those have been somewhat vague about how I actually decide on the stock/bond split, although not deliberately so.  If Ben Graham can shout out the Net Net method to the world over 50 years ago and not have its effectiveness affected, then surely my tiny wispers on the web can do my approach no harm.  In fact it may to some miniscule degree make the markets more efficient.  Like the proverbial fly stopping an oncoming supertanker.  Perhaps I may even win a Nobel Prize, but I doubt it.

Both Shiller and Smithers and others have shown that it is possible to value markets and that market valuations are bound by an invisible elastic thread to both earnings and assets.  More importantly, these valuations allow you to say something about the expected future returns.  Higher valuations mean lower expected returns and lower valuations mean higher expected returns.  Also, average valuations mean average expected returns. Shiller's CAPE (Cycically Adjusted Price Earnings) is my starting point when looking at earnings related valuations.  This is the ratio of current market price to the market's average real earnings over the past decade.  For the S&P500 the long term average CAPE is currently 16.35 and is shown below as the horizontal line.  The data for this can be found here.