Trader’s Narrative

Last month we looked at a simple method for valuing the market called Tobin’s Q. (To get details, check the previous link).

Working with the available data we had back then we surmised that the market had gotten much cheaper but that it was still not quiet at a level which had historically marked bear market bottoms. But using the forward estimate of a Q ratio expert (the most preeminent disciple of Tobin) we were expecting to find a flush down in the first quarter of 2009 taking us down to that level.

The Federal Reserve released its data for the first quarter of 2009 and unfortunately the estimate by John Mihaljevic was not borne out. This bear market is not finished - at least not according to Tobin’s Q ratio.

I’m not really sure how the eggheads at the Fed actually crunch the numbers for the numerator and the denominator but adjustments are the norm. Each quarter we not only have new data but usually small adjustments are made to prior numbers.

This most recent data release was no different with almost all previous data points changing slightly. For example, the 2008 fourth quarter data changed from 0.6208 to 0.6730. The only (thin) silver lining in this cloud is that we are continuing to head in the right direction: lower. But in order to give us a signal, the ratio has to fall precipitously to the 0.40 level. Which is not to say that it can’t do so.

In the first quarter of 1974 the Q ratio was 0.58, not far from where we find it now. During the next few quarters, it fell so fast that by the fourth quarter of 1974 it was 0.33 - at an extreme historic low, signaling a generational opportunity in the equity markets. You can mouse over the chart below to see what I mean.

By the way, if you haven’t yet, I highly recommend picking up a copy of Valuing Wall Street. It is the definitive book on this indicator and at only $10 even a cheap bastard like me can’t resist it. A little trivia: this book came out at the same time as “Irrational Exhuberance” but either because it had a useless publicist or because the concept was too dry, it never got the same traction as Prof. Shiller’s book - even though it argued correctly that the 2000 market was about to take a massive tumble.

You can get the most recent data as well as the archived files at this Federal Reserve page.