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Latest Tobin's Q Suggests Neutral One-Year, Bearish Five-Year U.S. Market Outlook

|Includes: SPDR S&P 500 Trust ETF (SPY)

In the new issue of the quarterly report Equities and Tobin's Q, former James Tobin research associate and Manual of Ideas editor John Mihaljevic provides an update on Tobin's Q using recently released data by the Federal Reserve. Mihaljevic puts Q in historical context in order to draw conclusions for the U.S. equity market outlook. For the first time, Mihaljevic also compares Tobin's Q to Shiller's ten-year P/E since 1900, finding a striking correlation between the two time series.

The following is an excerpt from the executive summary of the 47-page report:

  • Tobin’s Q increased from 0.73 at the end of the second quarter to 0.88 at the end of the third quarter, based on data provided by the Federal Reserve in a flow of funds release on December 10th. The sequential increase in Q of 21%, coming on the heels of a 20% increase from Q1 to Q2, was driven by an 18% increase in the numerator (market value) and a 2% decline in the denominator (replacement cost). Year-to-date, replacement cost is up 1%.
  • We estimate that Q has increased another 6% since September 30th, to 0.93 as of the market close on December 15th, based on Q3 figures contained in the Fed’s Z.1 release, adjusted to reflect the 6% return of the S&P 500 Index since the end of Q3. As our current estimate of Q is based partly on data expected to be updated in the next Z.1 release on March 11th, we base the market outlook in this report both on the Q3 estimate of Q as well as on our admittedly rough estimate of the Q ratio as of December 15th.
  • We conclude that the market outlook has not changed materially from our last quarterly update. Q still sends a neutral one-year market signal and bearish signals over three, five and ten years. The medium- to longer-term outlook has dimmed as a result of the rise in the S&P 500 since the end of Q2. If the S&P 500 fell back from 1,108 to 919, the index level on June 30th, the medium- to long-term outlook would move from bearish to neutral.
  • We form our neutral near-term and bearish longer-term outlook by putting recent increases in Q in historical context. Of the eleven instances when Q increased to at least 0.88, i.e., the level reached on September 30th, Q was higher one year later in five instances. Three out of eleven times, it was higher three years after the initial increase. Five years after the initial increase, Q was higher in only one of eleven instances. Ten years after the initial increase, Q was lower in all ten instances (one historical data point remains to be determined, as the initial increase occurred from 2002-03).

Read more about Tobin's Q and the U.S. equity market outlook.



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