Valuations Still Plump Post-Crash
Two years after the crisis, there's more room to fall.
March 10, 2011
For those keeping score at home, this week marks the second anniversary of the Great Market Bottom. Markets haven’t reached new highs since then – even the commodity turbo-charged TSX is still almost 1000 points off its June 2008 15,000 mark. (And it took a long way to get there from 2000’s previous high of 11,000.) As for the S&P 500, blogger dshort notes: “The S&P 500 closed the day down 0.14%, a muted commemoration of the second anniversary of the market bottom in 2009. The index is 95.1% above the March 9 2009 closing low, which puts it 15.7% below the nominal all-time high of October 2007.”
To put it in Churchillian terms, it’s not the beginning of the end, but at least the end of the beginning … beginning more than a decade ago. A bull cycle within a secular bear? Who knows exactly?
Still, valuations are looking plump. No post-Christmas diet here. Valuations are in the 20 times price range, above their average of 14, and certainly above the market low two years ago of nine times earnings, the Globe and Mail reports. Expansive but not necessarily expensive.
How about another ratio, Tobin’s Q? That’s something dshort continuously calculates, using Federal Reserve figures plus the performance of Vanguard’s Total Market ETF, to account for the two-month lag in updates. The figures are not comforting for those who think bottomish, that the market capitalization of stocks is approaching their replacement value after the Great SellOff.
“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. … 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.”
That’s the theory. What’s today’s reality? “The all-time Q Ratio high at the peak of the Tech Bubble was 1.82 — which suggests that the market price was 158% above the historic average of replacement cost. The all-time lows in 1921, 1932 and 1982 were around 0.30, which is about 57% below replacement cost. That’s quite a range.”
The historical average is about 0.72. And where are we today? “[T]he market remains significantly overvalued by historical standards — by about 72% in the arithmetic-adjusted version and 86% in the geometric-adjusted version.” In other words, it’s at 1.12, versus the average 0.72.
“Of course periods of over and under-valuation can last for many years at a time, so the Q Ratio is not a useful indicator for short-term investment timelines. This metric is more appropriate for formulating expectations for long-term market performance.”
But who was thinking long term in 1999? Beaten-up value managers, perhaps, without the capital to stick to their informed convictions? Many were bought – because their AUM seemed cheap at the time. Sadly.