Thursday, May 28, 2015

Nobel Winner’s Math Is Showing S&P 500 Unhinged From Reality.......

Nobel Winner's Math Is Showing S&P 500 Unhinged From Reality

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.

"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 stock 
prices are elevated and at risk.

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."



James Tobin, a Nobel Prize-winning economist at Yale University.

No comments:

Post a Comment