In response to a Bloomberg article which claimed that the S&P 500 is “unhinged from reality” based on the Tobin's Q ratio, Cullen Roche at Pragmatic Capitalism opined on Monday that the ratio is actually useless.
“But how useful is this ratio in reality?” he asked. “In my view, not very.”
“For instance, the Q ratio has been well above its historical average for most of the last 25 years. If you sold stocks when the ratio was above its historical average you’ve missed out on some huge gains.”
Roche is probably interested in timing the short-term direction of the market, and for that purpose, valuation metrics like the Tobin's Q ratio is, indeed, very probably useless, especially on their own.
Over the long term, though, valuation metrics like the Tobin's Q ratio are actually quite useful.
Just two weeks ago, John Hussman wrote that the correlation between the log of Tobin's Q and subsequent 10-year total nominal return of the S&P 500 is actually a respectable -0.85.
In that same post, I had again cited a Hussman post which showed that valuation measures have “provided clear guidance about expected market returns across a century of market history” and have “not failed at all even in recent decades”.
On the other hand, if Roche is actually interested in looking for signs that the market is about to turn rather than longer-term performance, then of course, valuation metrics like Tobin's Q are, on their own, not very useful.