Equities and Tobin's Q, 1900-2008 — Evaluating the Market Outlook in the Context of a Century of History, A Report By John Mihaljevic, CFA, Former Research Assistant to Economics Nobel Laureate James Tobin
The Manual of Ideas is launching a new quarterly report for investment managers and equity strategists entitled, "Equities and Tobin's Q — Evaluating the Market Outlook in the Context of a Century of History." The report is authored by John Mihaljevic, managing editor of The Manual of Ideas, and draws on his past experience as James Tobin's research assistant at Yale to provide unique perspective into this important indicator of future stock market performance. You can buy the current report or subscribe for the quarterly report and update service here.
The Debate: Is Today's Q Giving a Bullish or Bearish Signal for Equities?
Disagreement between leading investment managers and strategists has been remarkable. Consider the diametrically opposed views of two prominent figures:
Bill Gross, the outspoken Managing Director of PIMCO, a leading global investment firm with more than $790 billion in assets under management, asserts that the "Q ratio has almost never been lower and certainly not since WWII, implying extreme undervaluation..."
Meanwhile, Russell Napier, Strategist at CLSA, a leading international brokerage and investment group, claims that the Q ratio supports his expectation of a "horrific" market bottom and another 55% drop in the S&P 500 Index by 2014.
What Is Q Really Saying?
Find out in Tobin's Q and The Outlook for Equities. The report is uniquely equipped to answer this crucial question for equity strategists and portfolio managers:
* Authored by former James Tobin associate. John Mihaljevic is an Economics graduate of Yale who served as Professor Tobin's research assistant from 1996-98. One of Mr. Mihaljevic's key projects while serving in this capacity was to develop and implement a new technique of estimating Tobin's Q.
* Q estimation method used in report was developed in conjunction with James Tobin. Mr. Mihaljevic developed the technique applied in the report in 1996 with the assistance of Professor Tobin, updating the latter's previous method of calculating the Q ratio.
* Historical context reaching back more than 100 years. Tobin's Q and The Outlook for Equities includes data from 1900-2008, enabling the report author to put the current Q ratio in historical context, including the Panic of 1907 and the Great Depression.
About the Author — John Mihaljevic, CFA
Mr. Mihaljevic served as James Tobin's research assistant from 1996-98. In this capacity, Mr. Mihaljevic assisted Professor Tobin in developing a new Q estimation methodology and in periodically updating data related to the Q ratio. Mr. Mihaljevic also assisted Professor Tobin on a variety of macroeconomic research projects at the Cowles Foundation, including researching and editing Money, Credit and Capital, published by McGraw-Hill/Irwin in 1997.
Mr. Mihaljevic is a Chartered Financial Analyst and a summa cum laude graduate of Yale University, having earned distinction in Economics, his major course of study. In addition to working for and studying under James Tobin, Mr. Mihaljevic also studied under Yale Chief Investment Officer David Swensen and Sterling Professor of Economics William Nordhaus.
Mr. Mihaljevic has worked as an investment banker, equity research analyst and investment manager. He currently served as managing member of Mihaljevic Capital Management LLC and managing editor of The Manual of Ideas.
About the Report
In Equities and Tobin's Q, 1900-2008, Mr. Mihaljevic updates on a quarterly basis the Q estimation technique he developed with Professor Tobin in 1996-97. The inaugural report includes Flow of Funds data released by the Federal Reserve on December 11, discusses implications for equity investors, and puts the Q ratio in historical context. The report includes the following:
* Latest estimate of Tobin's Q, using data released by the Federal Reserve on December 11
* Implications for equity investors, based on placing the current Q ratio in historical context and interpreting it as James Tobin might have done
* Charts showing Q going back to 1900, including a comparison of three Q estimation methods: (1) Blanchard, Rhee and Summers, (2) Tobin (old), and (3) Tobin (new) -- Mr. Mihaljevic's calculation, developed jointly with Tobin in mid-1990s
* More than 100 years of Q data (1900-2008), provided in Excel via password-protected download link
* Subscription-based quarterly update service includes ongoing Tobin's Q updates based on the Fed's quarterly Flows of Funds release and other data, as well as commentary putting the latest ratio in historical context and evaluating implications for future market performance
About Tobin's Q
Tobin conceptualized the Q ratio as a measure of over- or undervaluation of publicly traded assets. In its simplest form, Q equals market value divided by replacement cost. If the market value of an asset exceeds the cost of replacing it (Q>1), there is an incentive to recreate that asset and immediately sell it in the market at a premium to cost. As a result, incremental real investment will tend to force high Q ratios back down to parity. No straightforward balancing mechanism exists in the case of low Q ratios, i.e., when the market is valuing an asset below its replacement cost (Q<1). When Q is less than parity, the market seems to be saying that the deployed real assets will not earn a sufficient rate of return and that, therefore, the owners of such assets must accept a discount to the replacement value if they desire to sell their assets in the market. If the real assets can be sold off at replacement cost, for example via an asset liquidation, such an action would be beneficial to shareholders because it would drive the q ratio back up toward parity. In the case of the stock market as a whole, rather than a single firm, the conclusion that assets should be liquidated does not typically apply. A low Q ratio for the entire market does not mean that blanket redeployment of resources across the economy will create value. Instead, when market-wide Q is less than parity, investors are probably being overly pessimistic about future asset returns. Several studies have shown that stock market investments at times when the q ratio was less than parity have produced above-average long-term returns.