Posted on 07/02/2011 4:31:36 PM PDT by blam
The Stock Market Is Overvalued Between 48% And 61%
Doug Short, DShort.com
Jul. 2, 2011, 8:16 AM
The Q Ratio is a popular method of estimating the fair value of the stock market developed by Nobel Laureate James Tobin. It's a fairly simple concept, but laborious to calculate. The Q Ratio is the total price of the market divided by the replacement cost of all its companies. Fortunately, the government does the work of accumulating the data for the calculation. The numbers are supplied in the Federal Reserve Z.1 Flow of Funds Accounts of the United States, which is released quarterly.
The first chart shows Q Ratio from 1900 to the present. I've estimated the ratio since the latest Fed data (through 2011 Q1) based on a combination of the price of VTI, the Vanguard Total Market ETF, and an extrapolation of the Z.1 data itself.
Interpreting the Ratio
The data since 1945 is a simple calculation using data from the Federal Reserve Z.1 Statistical Release, section B.102., Balance Sheet and Reconciliation Tables for Nonfinancial Corporate Business. Specifically it is the ratio of Line 35 (Market Value) divided by Line 32 (Replacement Cost). It might seem logical that fair value would be a 1:1 ratio. But that has not historically been the case. The explanation, according to Smithers & Co. (more about them later) is that "the replacement cost of company assets is overstated. This is because the long-term real return on corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is around 6.0%. Over the long-term and in equilibrium, the two must be the same."
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(Excerpt) Read more at businessinsider.com ...
I think it is fixed by the Fed, Goldman Sachs, and a lot of the other biggies. In a couple of years, all those 401k proceeds are going to be cashed in and you’ll see a drop like no other. The Fed is causing money to be printed, Goldman Sachs and the crew are doing dummy trades to push up prices and commissions, and most of the corporations are being looted of cash by the managers and directors.
As for the stock market, it is simply a matter of supply and demand. When stocks are in demand, prices go up. When demand falls, so do prices. Anyone with dollars is looking for some place to put them, and with real estate on the decline and new business ventures being taxed out the wazoo, the stock market becomes a better option. So more people invest, and prices rise.
I am, however, detecting early signs that this inverse relationship may be breaking down....so beware of relying on this as a “black box” type of thing. It has worked remarkably, insanely well for 2 years. By the way, there is little or no secret about it, either.
I’m not saying that the relationship will vanish; I am saying it may not be *by far* the most significant driver of stock prices which it has been. I suspect a weakening dollar, when it happens in compressed time periods will be decidedly bullish for equities for the foreseeable future, under almost any circumstances.
No, it’s certainly not a secret for those of us that study the market. But it is what it is. The charts show it. As to whether that inverse relationship has started to break down, who knows? Time will tell. All these kind of relationships seem to eventually break down.
The same inverse relationship exists between the dollar and precious metals, so in effect, the decline in the dollar is driving up the cost of PM’s, though the run to PM’s as a safe haven has exacerbated that rise in the US$ price of PM’s.
PING
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