We recently looked at a valuation methodology from Ford Equity Research which suggested that right now, the stock market is approximately fairly valued.
Since the most recent components of Tobin’s ratio (also known as Tobin’s Q) have been released by the Federal Reserve, I thought we would check in on the updated chart for it:
If you’re not familiar with this method of valuation, you should read “Valuing Wall Street” by Smithers & Wright.
As you can see, this method of valuation is also suggesting that we are close to parity. The most recent data point is for June 2009 at 0.91 (which by the way, will probably be declared as the end of the great recession).
Since then, the S&P 500 has risen approximately 24% so we can guesstimate that the present Tobin’s Q ratio is slightly higher; perhaps even above 1. In contrast, the lowest Tobin’s Q ratio during the bear market was for January 2009 at 0.64. But that didn’t last long. Contrast this with the time period from 1974 to 1984 when it hovered around 0.40.
Finally, isn’t it interesting to see the same parabolic rise and blow-off pattern in this economic indicator that we see so often in stock and commodity markets? Probably the most important iteration of this technical formation was the gold parabolic climax in late 2009. The price of gold still has not recovered that level.
Here are some recent comments from David Rosenberg (of Gluskin Sheff) on valuation:
- The median level of the S&P from our models is 970 based, on Q4 data inputs; and 1,120 based on Q1 estimates (based on credit spreads, earnings estimates/revisions, money supply and yield curve — credit spread improvement and yield curve steepening have had a big impact this quarter).
- Based on the Shiller normalized P/E ratio, the S&P 500 is 27% overvalued presently. That would put fair-value at 840. Note, however, that on average, the final blowoff phase to rallies takes the degree of overvaluation to 50%, which would be 1,350 on the S&P 500.
- On a Tobin Q replacement cost comparison, the S&P 500 is trading 22% above the long-run average. This would put fair-value at 890.
- Applying what would be a normal earnings increase in the context of 5% nominal GDP growth for 2009 would imply $65 for operating EPS. Applying a typical one-year forward multiple of 15x on that earnings stream would generate a 975 fair value estimate for the S&P 500.
- Technically, the market has just successfully broken through the 50% retracement level from the March lows — it did so at 1,120 on the S&P 500. Next critical Fibonocci retracement of 61.8% would imply a test of 1,225 on the index.
- So we have a combination of valuation and technical factors that would imply a low of 840 and a high of 1,350. The S&P 500 is around the 1,150 mark so it is 17% shy of what could be construed as a bubble peak; and 27% away from what could be construed as a natural corrective phase after a parabolic move from an oversold bottom.
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