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).
Disclosure: No positions