Slow Spending
Spending by companies on plants and equipment is lagging behind. While capital investment also rose to a record in 2014, its growth was 11 percent over the last two years, versus 45 percent in buybacks, data compiled by Barclays Plc show.
With equity prices surging and investment growth failing to keep pace, the Q ratio has risen to 58 percent above its average of 0.70 since 1900, according to data compiled by Birinyi and the Federal Reserve on market and asset values for non-financial companies. Readings above 1 are considered by some to be too high and the ratio has exceeded that threshold only 12 percent of the time, mostly between 1995 to 2001.
That’s nothing to be alarmed about because the American economy has become more oriented around services than manufacturing, according to George Pearkes, an analyst at Harrison, New York-based Bespoke Investment Group LLC. Nowadays, companies like Apple Inc. and Facebook Inc. dominate growth, while decades ago, it was railroads and steelmakers, which rely heavily on capital.
Mean Reversion
“Does that necessarily mean that the Q ratio should be as high as it is right now? I don’t know,” Pearkes said by phone. “With those sorts of long-term indicators, they can sometimes mean that the market is overvalued. But the reversion to the mean on them is usually going to take a lot longer than most people’s time frame.”
Any investors who based their investment decisions on the Q ratio would have missed most of the rally since 2009, according to Jeffrey Yale Rubin, director of research at Birinyi’s firm. The measure rose above its historic mean three months into this bull market and since then, the S&P 500 has climbed 131 percent.
“The issue we have with Tobin Q is that it does a very poor job at timing the market,” Rubin said from Westport, Connecticut. “The followers of Tobin Q never told us to buy in 2009, yet now we are warned that we should sell. Our response is sell what? We were never told to buy.”
Bond Yields
Everyone from Janet Yellen to Warren Buffett has spoken cautiously on stock valuations in the past month. Both the Fed chair and chief executive officer of Berkshire Hathaway Inc. said prices are at risk of getting stretched should bond yields increase. The rate on 10-year Treasuries slipped last week to 2.14 percent while the S&P 500 gained 0.3 percent.
“It’s probably a sensible configuration for the stock market to be overvalued because competing investments are so poor,” Robert Brusca, president of Fact & Opinion Economics in New York, said by phone. “As an investor, you’re not just looking at the value of the firm, but the value of the firm relative to other things you can do with your money.”
At 2,260 days, the bull market that began in March 2009 this month exceeded the 1974-1980 rally as the second longest since 1956. While measures such as price-to-earnings ratios are holding just above historical averages, the bull market’s duration is sowing anxiety among professionals who watched the previous two end in catastrophe.
“We’re still close enough to that prior experience and that hold-over effect is still there,” Chris Bouffard, chief investment officer who oversees more than $10 billion at Mutual Fund Store in Overland Park, Kansas, said by phone. “When you start to see prior cycle peaks on the chart like Tobin Q and any other valuation metrics that people are putting up there, it looks dramatic, stark and scary.”