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<\/p>\nQ-Ratio doesn\u2019t depend on projecting either earnings or revenue<\/p>\n
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Published: May 18, 2020 at 9:01 a.m. ET, By Mark Hulbert<\/p>\n
Who\u2019s right: David Tepper or Nelson Peltz?<\/p>\n
Tepper, the hedge fund titan who founded Appaloosa Management, said the stock market is the \u201csecond-most overvalued<\/a>\u201d he\u2019s ever seen. In contrast, Nelson Peltz, the Trian Partners chief executive, told CNBC that there is \u201cloads of value in the market<\/a>,\u201d that he\u2019s optimistic on the outlook for a COVID-19 vaccine, and that he\u2019s putting his capital to work.<\/p>\n It would be easy to just flip a coin, of course. If uber-wealthy managers on Wall Street can so disagree, despite having access to huge research budgets and top analysts, what insight can we possibly shed on the market?<\/p>\n This question takes on even more urgency right now, when companies literally have no idea what their earnings and revenue will be in coming quarters. As I pointed out a week ago<\/a>, quoting Kathleen Houssels, global chief investment officer at AXA Rosenberg Investment Management, \u201ctraditional Quant Factors like Value, Growth, and Quality will become virtually meaningless as the impact of the coronavirus hits company financial statements.\u201d<\/p>\n There nevertheless is one valuation indicator with an excellent long-term record that does not rely on either earnings or revenue projections: the Q-Ratio, which is calculated by dividing market value by the replacement cost of assets. This ratio was introduced by the late James Tobin, the 1981 Nobel laureate.<\/p>\n
| AS OF<\/th>\n | S&P 500\u2019S PROJECTED 10-YEAR ANNUALIZED REAL TOTAL RETURN<\/th>\n<\/tr>\n<\/thead>\n |
|---|---|
| Dec. 31, 2019<\/td>\n | -4.00%<\/td>\n<\/tr>\n |
| All-time high on Feb. 19<\/td>\n | -4.70%<\/td>\n<\/tr>\n |
| Market low on March 23<\/td>\n | -1.10%<\/td>\n<\/tr>\n |
| End of the first quarter<\/td>\n | -2.20%<\/td>\n<\/tr>\n |
| May 14<\/td>\n | -3.00%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n As you can see, the S&P 500\u2019s projected return today is nearly two annualized percentage points worse than it was at the market low on March 23, and only one annualized percentage point better than it was at the beginning of the year.<\/p>\n What about the next 12 months?<\/p>\n As with any valuation indicator, the Q-Ratio sheds relatively little light on the market\u2019s shorter-term returns. The r-squared is just 5%, in fact, when the ratio is used to predict the S&P 500\u2019s 12-month returns\u2014only a tenth of what it is in the case of 10-year returns.<\/p>\n In any case, the Q-Ratio currently projects that the dividend-adjusted S&P 500 will produce a return over the next 12 months that is 0.9% below inflation.<\/p>\n Whether you consider that good or bad news depends on your expectations. If, like some, you believe that economy is about to enter a dark winter of global depression<\/a>, a 0.9% loss doesn\u2019t seem all that awful a prospect. But you\u2019ll be disappointed if you were counting on a quick V-shaped recovery that takes the stock market back to new all-time highs.<\/p>\n Don\u2019t forget, however, that the Q-Ratio\u2019s projection of the market\u2019s return over the next 10 years carries a lot more confidence than its 12-month forecast.<\/p>\n Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.<\/em><\/p>\n |