Q Ratio Signals âHorrificâ Market Bottom, CLSA Says (Update1)
http://www.bloomberg.com/apps/news?pid=20601087&sid=aKNSK0gYlqB0&refer=home
By Patrick Rial
Dec. 10 (Bloomberg) -- A global stock slump may have further to go, according to Tobinâs Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.
The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, indicates the Standard & Poorâs 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the S&P this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to a trough of 400 by 2014, the strategist said.
âThings have always looked absolutely terrible at the bottom,â said Napier, Institutional Investorâs top-ranked Asia strategist from 1997-1999. With deflation âthe value of assets falls and the value of debt stays up, then equity gets crushed. The results are always horrific.â
Shares have fallen this year as the worst financial crisis since the Great Depression caused almost $1 trillion of losses at institutions around the globe and dragged the worldâs largest economies into recession. The MSCI World Index has tumbled 44 percent in 2008, set for the biggest annual decline in its four- decade history.
Bear-Market Scholar
Napier, who teaches at Edinburgh Business School, based his S&P 500 forecast on the Q for U.S. equities as well as the 10- year cyclically adjusted price-to-earnings ratio, another measure of long-term value.
Before the trough in 2014, investors are likely to see a so-called bear market rally for the next two years as central bank actions delay the onset of deflation, he said.
The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, the author of âAnatomy of the Bear,â a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.
When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.
At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.
Quantitative Easing
Measures such as Tobinâs Q ratio and a 10-year price-to- earnings ratio are âvaluable tools,â said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $190 billion. Milligan said he is bullish on U.S. equities for now as central bank efforts to fight deflation will push the market higher.
âFor those who are worried about losing much of their investment almost overnight, very clearly youâd want to wait for those signals to give a much stronger case,â he said. The bear market will have âa painful resolution, itâs just a question of how painful, over what period of time and for what parties.â
Federal Reserve Chairman Ben S. Bernankeâs indication that he will use âquantitative easingâ to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.
The governmentâs efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said.
âBear markets always end for exactly the same reason, and that is the market begins to price in deflation,â he said. âEquities will be incredibly cheap.â
http://www.bloomberg.com/apps/news?pid=20601087&sid=aKNSK0gYlqB0&refer=home
By Patrick Rial
Dec. 10 (Bloomberg) -- A global stock slump may have further to go, according to Tobinâs Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.
The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, indicates the Standard & Poorâs 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the S&P this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to a trough of 400 by 2014, the strategist said.
âThings have always looked absolutely terrible at the bottom,â said Napier, Institutional Investorâs top-ranked Asia strategist from 1997-1999. With deflation âthe value of assets falls and the value of debt stays up, then equity gets crushed. The results are always horrific.â
Shares have fallen this year as the worst financial crisis since the Great Depression caused almost $1 trillion of losses at institutions around the globe and dragged the worldâs largest economies into recession. The MSCI World Index has tumbled 44 percent in 2008, set for the biggest annual decline in its four- decade history.
Bear-Market Scholar
Napier, who teaches at Edinburgh Business School, based his S&P 500 forecast on the Q for U.S. equities as well as the 10- year cyclically adjusted price-to-earnings ratio, another measure of long-term value.
Before the trough in 2014, investors are likely to see a so-called bear market rally for the next two years as central bank actions delay the onset of deflation, he said.
The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, the author of âAnatomy of the Bear,â a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.
When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.
At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.
Quantitative Easing
Measures such as Tobinâs Q ratio and a 10-year price-to- earnings ratio are âvaluable tools,â said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $190 billion. Milligan said he is bullish on U.S. equities for now as central bank efforts to fight deflation will push the market higher.
âFor those who are worried about losing much of their investment almost overnight, very clearly youâd want to wait for those signals to give a much stronger case,â he said. The bear market will have âa painful resolution, itâs just a question of how painful, over what period of time and for what parties.â
Federal Reserve Chairman Ben S. Bernankeâs indication that he will use âquantitative easingâ to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend.
The governmentâs efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said.
âBear markets always end for exactly the same reason, and that is the market begins to price in deflation,â he said. âEquities will be incredibly cheap.â
