Tobin's Q ratio fits in nicely with TJ's view that the real crisis comes in 5-7 years. In the case of Tobin, 2014.
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Tobin’s Q Ratio Indicates ‘Horrific’ Market Bottom, CLSA Says
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By Patrick Rial
Dec. 10 (Bloomberg) -- The 2008 slump in global equities has further to go if Tobin’s Q ratio is any guide, according to CLSA Ltd. strategist Russell Napier.
The ratio, a method of valuing U.S. companies developed by Nobel Prize laureate economist James Tobin, indicates that the Standard & Poor’s 500 Index, set for its worst year since 1931, may sink by another 55 percent to 400 when the market bottoms around 2014, London-based Napier said. The ratio divides total market capitalization by the cost of replacing assets.
“Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997- 1999. “If 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. The S&P 500 is down 39 percent this year.
Global indexes are likely to track any decline in the U.S. gauge, said Napier, who also based his prediction for the index on a 10-year cyclically adjusted price-to-earnings ratio. 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, who authored “Anatomy of the Bear,” a study of bear-market bottoms. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.
‘Valuable Tools’
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.
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.
“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.”
To contact the reporter for this story: Patrick Rial in Tokyo at prial@bloomberg.net. |
