Econintersect: Analyst Doug Short reports that one measure of relative stock valuation, the Tobin-Q ratio, is screaming over valued. The ratio is now higher than at any time in the past 110 years except for the dot.com bubble of the late 1990’s. The Q-ratio is higher than the peaks before the crash of 1903, the crash of 1907, the crash of 1929, the market peak in 1937, the market peak in 1966, the crash of 1973-74 and the crash of 2008-09.The average decline after the previous peaks was 50.5% (Dow Jones Industrial Average). The smallest decline was 30% in the bear market of 2000-02. The largest decline was 1929-32 when the Dow lost 89%. So there have been 8 previous peaks in the Tobin-Q ratio and these have been followed by the 8 biggest bear makets of the past 110 years.
Of course, eight is not a overwhelming sample size. There is a statistical chance that can not be dismissed completely that this time the high Q-ratio will be precurser to a different outcome. If the correlation of the Q-ratio with subsequent stock market performance is purely random, then the eight in a row observation is a result with a probability of 0.39% (3.9 chances out of a thousand). Also, there is no telling how much higher both the Tobin-Q and the markets can go before there is another decline. From the time the Q ratio reached this level in the dot.com bubble until the ultimate peak was reached took over four years and the market didn’t peak for 4 1/2 years. Vast amounts of money were made for those who rode that rocket ship to the top and then got out before the bear market that bottomed in 2002.
However, to ignore the high Q-ratio is the same as placing a bet with the odds 99.61% against you.
Source: GEI Investing and dshort.com
