According to Tobin's Q the Bear Market Isn't Over Yet

Last month we looked at a simple method for valuing the market called Tobin’s Q. (To get details, check the previous link).

Working with the available data we had back then we surmised that the market had gotten much cheaper but that it was still not quiet at a level which had historically marked bear market bottoms. But using the forward estimate of a Q ratio expert (the most preeminent disciple of Tobin) we were expecting to find a flush down in the first quarter of 2009 taking us down to that level.

The Federal Reserve released its data for the first quarter of 2009 and unfortunately the estimate by John Mihaljevic was not borne out. This bear market is not finished - at least not according to Tobin’s Q ratio.

I’m not really sure how the eggheads at the Fed actually crunch the numbers for the numerator and the denominator but adjustments are the norm. Each quarter we not only have new data but usually small adjustments are made to prior numbers.

This most recent data release was no different with almost all previous data points changing slightly. For example, the 2008 fourth quarter data changed from 0.6208 to 0.6730. The only (thin) silver lining in this cloud is that we are continuing to head in the right direction: lower. But in order to give us a signal, the ratio has to fall precipitously to the 0.40 level. Which is not to say that it can’t do so.

In the first quarter of 1974 the Q ratio was 0.58, not far from where we find it now. During the next few quarters, it fell so fast that by the fourth quarter of 1974 it was 0.33 - at an extreme historic low, signaling a generational opportunity in the equity markets. You can mouse over the chart below to see what I mean.

By the way, if you haven’t yet, I highly recommend picking up a copy of Valuing Wall Street. It is the definitive book on this indicator and at only $10 even a cheap bastard like me can’t resist it. A little trivia: this book came out at the same time as “Irrational Exhuberance” but either because it had a useless publicist or because the concept was too dry, it never got the same traction as Prof. Shiller’s book - even though it argued correctly that the 2000 market was about to take a massive tumble.

You can get the most recent data as well as the archived files at this Federal Reserve page.

Comments

[TradingHelp...:]

Great post. I agree we are not cheap yet... but then not depressing expensive either.

Jun 25 11:26 AM

[thiazole:]

Maybe - there is still a lot of variability in this index. The first recession of the secular bear market of the 70s saw the index fall to 0.6. The first recession of the secular bear market of the 2000s only saw the index fall to 0.8.

The secular bull market of the 50s and 60s saw it rise to just over 1. The secular bull market of the 80s and 90s saw it rise to 1.8. It is really hard to conclude that it has to fall back below 0.4 considering that since the early 90s (which was the beginning of a greater participation rate in investing in securities) the market has been trading at a much higher Q ratio than historical values. 20 years is a aweful long time to just be an anomoly.

Jun 25 11:39 AM

[tradeking13:]

To get to a q-ratio below 0.40, what level would the S&P have to get to?

Jun 25 12:03 PM

[Larry House:]

That we are still in a bear market is not surprising; what has been surprising is how quickly so many called it over and all problems solved just because the markets improved over the past three months. We have many severe economic problems that are still not resolved.

Jun 25 12:10 PM

[thiazole:]

You don't have to solve all the problems for a recession to end. Other than popping the stock market bubble, what problems did the last recession fix? We had many of the same problems then that we have now, but the economy still recovered.

I like the 1970-1982 era as a nice example of a LOT of problems that required 4 separate recessions to solve. Each recession solved some of the problems, but each ended without solving them all. Even after those 4 recessions, we still had a serious budget deficit problem that wasn't solved.

The biggest and most obvious problem that this recession has successfully solved was the housing market bubble. Another that was alleviated (for a while anyway) was painfully high oil prices. If solving those two problems are enough to free up the kind of capital required for the economy to grow again, then for now they are enough to end THIS recession. We will have more recessions that will address other problems over the next 10 years, though.

On Jun 25 12:10 PM Larry House wrote:

> That we are still in a bear market is not surprising; what has been
> surprising is how quickly so many called it over and all problems
> solved just because the markets improved over the past three months.
> We have many severe economic problems that are still not resolved.

Jun 25 12:21 PM

[DrBenway:]

I am very curious how Tobin Q accounts for a shift from manufacturing to the service (or other low tangible assets industries) in the last 20 years. I am not sure you can judge Apple or Oracle's stock price by its "replacement" costs (what are we "replacing" exactly?).

I agree that Tobin's Q is somewhat useful on a relative scale when comparing to the recent past. On the absolute scale, it is "apples and oranges."

I also think that P/E ratio comparison used by Schiller is wildly misleading. During recessions, P/E are often getting larger as earnings go down (or even turn negative) faster than prices.

I am wondering if anyone came up with a decent DCF measure for the market, isn't the only measure that is truly relevant?

Jun 25 12:29 PM

[TurtleTrader72:]

From a technical perspective, this recent correction is not over. I have recently noticed that VIX (a fear/greed indicator) has been heading lower despite the overal market heading lower as well. What this is implying is that this recent down trend has not caused any concerns (fear) with investors which is a worrisome thing (at least for the bulls). As the market has moved lower, investors have actually become more bullish (complacent). The VIX is commonly used as a inverse indicator where high numbers signal fear (market bottoms) and low ones indicate complacency (market tops). Historically, the VIX has been better at spotting markets bottoms than tops. Probably because fear is a much more intense and short lived condition where as complaceny can drag on for months and even years. From my experience, one of the worst things to have (if your a bull) is a correcting market coupled with a downtrending VIX as this usually means more downside to come. Depsite having a strong day, i feel that the market will head lower over the coming weeks.

Jun 25 01:33 PM

[InnocentsAb...:]

Thanks so much for the nice article. And the updates on indicators.

Jun 25 01:55 PM

[twitee:]

With the Fed manipulation, all theories and facts are out of the window!Who says the housing issue is over? it has not even began yet? Many homeowners are not paying mortgages in the last 9 month to a year without a foreclosure! However, the banks are rallying! Go figure the rest!
When you are dealing with worthless printed paper money everything is corrupted....

Jun 25 02:04 PM

[bartpr:]

it is impossible to judge how low t/q will go before a new bull market starts. it may do like it has in the past, move in a range for years before a bottom is realized. looking at the 16 year up and 16 year down cycle we are in year 9 of down, so there may be a long ways to go yet. in the meantime try to play out this up move in a long bear down. get out after the next twenty weeks. this will have been approx 200 trading days from the bottom, the average time of a up move after a bear decline of 45% or more.

Jun 25 02:13 PM

[thiazole:]

So why even use this forum? Heck, maybe we aren't even in a recession. Maybe the whole thing was invented by the government to get more control over the economy. Maybe there really aren't that many foreclosures, but the government is tricking us into believing there are.

Once you let paranoia into economics, there is no longer any point in discussing it. Either you believe the data and discuss what it means or you don't believe it and therefore have nothing to say. There is no sense in posting that you don't believe and therefore want the rest of us to stop discussing it.


On Jun 25 02:04 PM twitee wrote:

> With the Fed manipulation, all theories and facts are out of the
> window!Who says the housing issue is over? it has not even began
> yet? Many homeowners are not paying mortgages in the last 9 month
> to a year without a foreclosure! However, the banks are rallying!
> Go figure the rest!
> When you are dealing with worthless printed paper money everything
> is corrupted....

Jun 26 05:39 PM