Tobin’s Q ratio: S&P may plunge another 55 percent to 400; Massive Deflation To Come

Discussion in 'Wall St. News' started by ByLoSellHi, Dec 10, 2008.

  1. Q Ratio Signals ‘Horrific’ Market Bottom, CLSA Says (Update1)

    By Patrick Rial

    Dec. 10 (Bloomberg) --
    A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.

    The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, indicates the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the S&P this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to a trough of 400 by 2014, the strategist said.

    “Things have always looked absolutely terrible at the bottom,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. With deflation “the value of assets falls and the value of debt stays up, then equity gets crushed. The results are always horrific.”

    Shares have fallen this year as the worst financial crisis since the Great Depression caused almost $1 trillion of losses at institutions around the globe and dragged the world’s largest economies into recession. The MSCI World Index has tumbled 44 percent in 2008, set for the biggest annual decline in its four- decade history.

    Bear-Market Scholar

    Napier, who teaches at Edinburgh Business School, based his S&P 500 forecast on the Q for U.S. equities as well as the 10- year cyclically adjusted price-to-earnings ratio, another measure of long-term value.

    Before the trough in 2014, investors are likely to see a so-called bear market rally for the next two years as central bank actions delay the onset of deflation, he said.

    The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.

    When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.

    At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.

    Quantitative Easing

    Measures such as Tobin’s Q ratio and a 10-year price-to- earnings ratio are “valuable tools,” said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $190 billion. Milligan said he is bullish on U.S. equities for now as central bank efforts to fight deflation will push the market higher.

    “For those who are worried about losing much of their investment almost overnight, very clearly you’d want to wait for those signals to give a much stronger case,” he said. The bear market will have “a painful resolution, it’s just a question of how painful, over what period of time and for what parties.”

    Federal Reserve Chairman Ben S. Bernanke’s indication that he will use “quantitative easing” to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.

    The government’s efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said.

    “Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “Equities will be incredibly cheap.”
  2. Bloomberg Live is talking about Tobin's Q Ratio right now.
  3. tradersboredom

    tradersboredom Guest

    where are investors going to go.

    it's a global market.

    a market crash or credit crunch in US is affecting all markets from Asia to Europe.

    once the deleveraging process is complete it's back to business as usual.

  4. What SP500 level did the Q ratio predict in 2002?
  5. Not quite, I don't think.

    There will be some sort of slow recovery... from much lower levels... with more conservative lending/borrowing/spending.

    Nearly everyone will have to adjust to a "slower pace of everything" financial and economic.... unless of course, inflation is running amok... which is likely.
  6. Low interest rates in the US and a devalued dollar will certainly finance growth in the rest of the world in the same way the cheap yen has for the last two decades. This will reboot credit markets and will prevent a Great Depression style deflation. It'll also curb real growth in the US for atleast two decades.

    This is the other side of the bail-out of non performing financial institutions and auto makers. It means that the production of the American people will be devalued in order to finance the construction of shopping malls in Asia and other parts of the world.
  7. tradersboredom

    tradersboredom Guest

    the market activity in the last five years has been hot.

    look at the CME volume compared to even the 90's

    returning to normal activity from rampant hot activity.

  8. blah blah blah none of this means anything.
  9. TGregg


    No way deflation, not unless the fed wants it. Wanna pull out the stops and put an end to deflation? Send a 100 grand "rebate" check to everybody. Hello inflation.
  10. At the rate the gov spends money since the early 80's deflation will never be an issue
    #10     Dec 10, 2008