- Tobin’s Q And Why Etai Friedman Thinks The S&P 500 Will Drop 80%
by Nicholas Donato , Benzinga Staff Writer, http://www.benzinga.com/
Calling for an 80 percent drop in the S&P 500 is a bold claim, one that not too many people would make, unless they were convicted in their belief. Meet Etai Friedman, CEO of Eyal Capital Management, formerly of MKM Partners and Steve Cohen’s SAC Capital. Etai points to an oft-used metric, Tobin’s Q, to state part of his case in a series of articles describing his extremely bearish outlook of the U.S. economy.
If you missed class on the day your finance professor reviewed Tobin’s Q, here’s a quick breakdown. “The Q Ratio” was developed by James Tobin, an American Economist, who was awarded a Nobel Prize for his work in Economics. It’s actually a fairly straightforward equation: You take the total market value of the market, plus liabilities, and divide it by the book value of the market, plus liabilities.
An in-depth look of Tobin’s Q can be found in the book “Valuing Wall Street,” as well as from this link by Advisor Perspectives. However, the main point is this: Since 1900, an arithmetic mean for Q Ratio is 0.68. The highest this ratio has ever been is 1.64 during the Tech Bubble. While the lowest Q Ratio has ever been is 0.30 during the Great Depression as well as the 1982 economic recession. Etai believes that due to the Fed’s manipulation of markets, we’re heading to these lower Q ratio levels sooner rather than later.
Etai gives a brief overview of the Q-ratio:
“Over the last 100 years it’s been in a range, and that range is on the low side. It’s gotten as low as 0.3 several times, including during the Depression, but not just during the Depression. On the high side it’s gotten up to maybe 1.15, maybe 1.20. That was let’s say in 2000. In May of 2015 it hit 1.10 or 1.12 and it hit a fairly high watermark.”
Etai then gives his grim outlook:
“I believe because the Fed does not have the tools to engineer another bailout like they did in 2007, I think Tobin’s Q is going to go to 0.3. So I envision, take the S&P 500 top to bottom I think it’s going to drop 80% over the next couple of years. It may take three years, four years, or two years. I can’t tell you how long it’s going to take but I’m anticipating an 80% drop or 70% drop, something in that neighborhood. Tobin’s Q got down to 0.54 in 2009.”
As for the reason we got here, Etai didn’t hold back on his criticism of the Fed:
“The reason it didn’t go lower is because we had the biggest fucking bailout ever orchestrated in the history of the banking system. If that had not happened, you know equities would have gone down a hell of a lot more. Things would have been trading for a fraction of book value.”