13 March 2009

A prediction: the S&P 500 will fall to 500

The US Flow of Funds Accounts figures for the fourth quarter were released yesterday and Tobin’s Q is at 0.62. In other words, at the end of last year the ratio between the market value of US corporations and the net worth of their assets was below its historical average for the first time since 1988 and the stock market was therefore fairly valued in historical terms.

However, this does not mean that market valuations won’t fall further.

In the past, the end-of-year value of Q has in some years fallen to not much more than half its long-term average, as it did in 1981 (56%), 1974 (53%), 1948 (52%) and before that in 1941, 1931 and 1920.

If we see similar behaviour this time, then the S&P 500, which stood at around 900 at the end of December, might be expected to fall to around 500—about a third lower than its current level of 750—before turning upwards again.

d. sofer