If you sold every share of every company in the U.S. and used the money to buy up all the factories, machines and inventory, you’d have some cash left over. That, in a nutshell, is the math behind a bear case on equities that says prices have outrun reality.
The concept is embodied in a measure known as the Q ratio developed by James Tobin, a Nobel Prize-winning economist at Yale University who died in 2002. According to Tobin’s Q, equities in the U.S. are valued about 10 percent above the cost of replacing their underlying assets -- higher than any time other than the Internet bubble and the 1929 peak.
Valuation tools are being dusted off around Wall Street as investors assess the staying power of the bull market that is now the second longest in 60 years. To Andrew Smithers, the 77- year-old former head of SG Warburg’s investment arm, the Q ratio is an indicator whose time has come because it illuminates distortions caused by quantitative easing.
“QE is a very dangerous policy, in my view, because it has pushed asset prices up and high asset prices, we know from history, are very dangerous,” Smithers, founder of Smithers & Co. in London, said in a phone interview. “It is very strongly indicated by reliable measures that we’re looking at a stock market which is something like 80 percent over-priced.”
Dissenting Views
Acceptance of Tobin’s theory is at best uneven, with investors such as Laszlo Birinyi saying the ratio is useless as a signal because it would have kept you out of a bull market that has added $17 trillion to share values. Others see its meaning debased in an economy whose reliance on manufacturing is nothing like it used to be.
To Smithers, the ratio’s doubling since 2009 to 1.10 is a symptom of companies diverting money from their businesses to the stock market, choosing buybacks over capital spending. Six years of zero-percent interest rates have similarly driven investors into riskier things like equities, elevating the paper value of assets over their tangible worth, he said.
The Standard & Poor’s 500 Index was little changed at 10 a.m. in New York.
Members in the benchmark gauge last year spent about 95 percent of their profits on buybacks and dividends, with stock repurchases exceeding $2 trillion since 2009, data compiled by S&P Dow Jones Indices show.
In the first four months of this year, almost $400 billion of buybacks were announced, with February, March and April ranking as three of the four busiest months ever, according to data compiled by Birinyi Associates Inc.