Valuing Wall Street: Protecting Wealth in Turbulent Markets [Hardcover]

Andrew Smithers (Author), Stephen Wright (Author)

Book Description

Publication Date: March 24, 2000

This comprehensive guide applies James Tobin's Q ratio to today's stock market - and finds that Wall Street is dangerously overvalued! It demonstrates how to calculate Q, how to use it to decide which stocks to buy, when markets will plunge, and take protective steps before it is too late.

Editorial Reviews

Amazon.com Review

"Most books about the stock market tell you how to make money. This one ... will show you how to avoid losing it," begins this smart, blunt, cautionary tale based on Nobel laureate James Tobin's 1969 "q ratio," which posits, among other things, that no matter how bullish a market gets, it's bound to snap back into place at some point--and those who don't brace for the reversal will feel its sting. The authors, one a prominent asset-allocation adviser and the other a former head of macroeconomic forecasting for the Bank of England, warn that it's only a matter of time before the overexuberant market of the early 21st-century topples like its counterparts in 1929 and 1968. Here they set out to show why and how this will happen--as well as to tell stockholders what they should and should not do if they want to emerge intact.

After making a cogent new argument in defense of the still-controversial q ratio, the authors show how it plays into principles of stock-market risk and return, how it has determined the value of Wall Street in the past and will continue to do so, and how to apply it as a practical investing tool. They do a neat job of parsing the good and bad news about stocks as a sound investment for the future, and of what to do and not do with one's money come the inevitable bear market. From there, they get down to the nitty-gritty of valuing the stock market, providing four key tests for any indicator of value and explaining how to fold in such factors as the dividend yield, the price-earnings ratio, the adjusted price-earnings multiple, yield ratios, and yield differences. They wrap up with a look at what they call "the q debate" among both economists and stockbrokers, and finally, they apply the q ratio specifically to the U.S. economy, rebuking Alan Greenspan's Federal Reserve for its role in what they see as the coming U.S. bubble burst.

With its plain English, helpful illustrated charts, vivid examples from history, and even the occasional employment of the likes of Alice in Wonderland to prove its points, Valuing Wall Street should be accessible to those with a working understanding of the market and economic principles. All told, this book is not so much a how-to as it is a theoretical forecast whose tidings investors might want heed as we near what Smithers and Wright warn are rough years ahead. --Timothy Murphy

From the Back Cover

A Reality Check on Today's Stock Market­­Including Easy-to-Follow Strategies for Protecting Your Assets.

"Wonderfully readable, this book's clear, direct logic borrows on Jim Tobin's concept of q to explain why the marvelous past is not only not prologue to perpetually higher and higher market valuations, but is the probable cuase of future returns being so small at best, and at worst, perhaps suddenly reversed."

­­Charles Ellis, Managing Partner, Greenwich Associates

"Andrew Smithers is one of the five best, most dispassionate, erudite analysts in the world. This is a book to read and chew on."

­­Barton Biggs, Global Investment Strategist, Morgan Stanley Dean Witter

"It takes a brave man to forecast the movement of the markets. But Andrew Smithers and Stephen Wright are the Cassandras of the New York Stock Exchange. Armed with an analysis based on q, the ratio between stock market prices and underlying capital value, they predict that the NYSE is facing a severe fall. They make their case clearly and forcefully. Investors should read and beware."

­­Professor Charles Goodhart, Monetary Policy Committee, Bank of England

"Andrew Smithers & Stephen Wright make a powerful economic argument that the New York stock market is 'wildly overpriced,' with shares 'at ridiculous levels,' calculated by them using Nobel Laureate James Tobin's q, or the ratio of share price to net worth of companies, at 1 1/2 times."

­­Professor Charles Kindleberger, Massachusetts Institute of Technology

"Smithers and Wright provide a guiding principle, based on theory, common sense and history, that should help all investors­­professional or amateur­­achieve better long run returns at much lower risk. The authors are currently serious bears; to pay attention to their case now could be the reader's most important financial decision."

­­Jeremy Grantham, Grantham, Mayo, Van Otterloo

See all Editorial Reviews

Product Details

• Hardcover: 352 pages
• Publisher: McGraw-Hill Companies; 1st edition (March 24, 2000)
• Language: English
• ISBN-10: 0071354611
• ISBN-13: 978-0071354615
• Product Dimensions: 9.3 x 6.3 x 1.4 inches
• Shipping Weight: 1.4 pounds
• Average Customer Review: 3.9 out of 5 stars  See all reviews (20 customer reviews)
• Amazon Best Sellers Rank: #1,025,666 in Books (See Top 100 in Books)

More About the Author

Andrew Smithers founded Smithers & Co., Ltd., and is regularly quoted in The New York Times, Barron's, Forbes, and other important publications. Stephen Wright spent several years as head of macroeconomic forecasting for the Bank of England, and now teaches and researches at Birkbeck College, University of London.

Customer Reviews

Most Helpful Customer Reviews

106 of 106 people found the following review helpful:

5.0 out of 5 stars Much better than Shiller's new book, April 20, 2000

By 

David Roth (Oakland, CA) - See all my reviews

This review is from: Valuing Wall Street: Protecting Wealth in Turbulent Markets (Hardcover)

Smithers and Wright have written a very compelling indictment of today's stock prices. They argue that prices are way too high by historical standards, and exhort us to SELL. This is the same conclusion reached by Yale Professor Robert Shiller in his new book "Irrational Exuberance"; however, Smithers and Wright are much more convincing.

Smithers and Wright use as a measure of valuation for stocks a statistic called "q" (or Tobin's q, named after Nobel laureate and Shiller colleague James Tobin). q represents the value of equities divided by the cost of replacing the underlying capital stock. So you might expect the stock market to be worth somewhere near q=1, where companies are worth what it cost to build them; historically, the average value of q is near 1.

Smithers and Wright show that changes in q and equity prices are almost identical, since the cost of replacing the capital stock changes so little. They also show that high values of q are associated with terrible subsequent returns. They show how a simple strategy of selling when q rises to 1.5 and buying again when q falls below 1 * trounces * a buy-and-hold strategy. And they top it all off by showing that today's level of q, around 2.5, is unprecedented. So SELL!

The reason the book is so much better than Shiller's is that Smithers and Wright give a coherent, fact- and theory-based argument for why q should be used to value stocks, not just P/E, stock earnings yield compared to bond earnings yield, or other popular measures. Shiller just used P/E and told us to sell due to today's high P/E; he did not even consider, not to mention try to debunk, other theories of valuation.

Smithers and Wright point out, for example, that in the early '30s, P/E was very high due to the depressed depression-era profits of companies, but that q was very low, providing the buy signal of a lifetime that would have been missed by looking at P/E alone.

The only negatives of this otherwise excellent book are: (1) Like most finance books, this one would gain from adding computations of after-tax returns, which shift us away from fancy trading strategies and towards buy-and-hold in taxable accounts. (2) They should admit that there are significant differences between today's economy and economies of the past. For example, in an economy such as ours where intellectual property is paramount and provides barriers to entry, firms' values may stay above the cost of replacing capital.

43 of 50 people found the following review helpful:

3.0 out of 5 stars A valiant effort to rationalize a poor metric....., August 10, 2000

By 

hiscapital "hiscapital" (London) - See all my reviews

This review is from: Valuing Wall Street: Protecting Wealth in Turbulent Markets (Hardcover)

Smithers and Wright tell us they have undertaken a statistical study of the relationship between the market value of US equities and the net worth of the underlying firms (as expressed by the ratio known as "Tobins q") and that their analysis reveals a strong tendency for this ratio to revert to its long-run mean of .65. As Tobins q is currently measuring in the area of 1.5, the authors conclude that the US stock market is overvalued and likely to decline by more than 50%. Based on about 100 years of data, the authors provide an estimate (using confidence intervals) of how soon this mean reversion is likely to occur.

The best service Smithers and Wright have provided in VWS is in demonstrating that contrary to popular wisdom (and books by other authors), a "buy and hold" approach to investing in the stock market has not necessarily provided a sure path to riches (or even a comfortable retirement). How well an investor has done depends crucially on, 1) what year he/she began investing in stocks, 2) the duration over which he/she invested, and 3) the year in which he/she retired. Over many periods, investors would have earned a much higher risk-adjusted return by holding bonds or cash instead of stocks. Thus, the authors conclude that with stocks set to decline by over 50% in the near future, any investor with less than, say a twenty year time horizon, would be well-advised to sell their stocks now.

Of course, Tobins q only serves as a reliable indicator of future stock market performance if the factors responsible for its accuracy in the past are still valid today. Some of the other reviewers here have done a good job of pointing out the problem with measuring corporate net worth exclusively in terms of real assets. If US corporations were to capitalize (rather than expense) all of their investments in intangible assets, net worth would be significantly higher and Tobins q would not appear quite so top-heavy. Smithers and Wright attempt to discredit this point by suggesting that for every firm that adds value to its balance sheet (through intangible assets that perform well), there is another firm that destroys value (through intangibles that perform poorly). Thus, their argument goes, in the aggregate corporate net worth is no higher than what is reflected by real assets in the denominator of q. The problem with this defense is that one could logically make the same argument for real assets. For every factory or machine tool that adds value to a company by contributing to profits, there is probably a factory or machine tool at another firm which contributes to loss making. The logical (but absurd) conclusion of this line of reasoning is that in the aggregate, the real net worth of US corporations is ZERO.

Smithers and Wright are supposedly economists by training but they have forgotten the first rule of economic valuation: sunk costs are irrelevant. The reason Tobins q is unlikely to accurately predict fair value in the stock market is that intrinsic value is not calculated by adding up total net assets but rather by discounting to the present time, the future cash flows which those assets can be expected to produce. Clearly, today's investors in the US stock market believe that is a very large figure indeed. Perhaps for their next book, the authors can assess the probability that these expected cash flows will actually materialize. That would tell us whether or not the stock market is overvalued and if so, by how much.

14 of 14 people found the following review helpful:

5.0 out of 5 stars Entertaining, Readable, and Thought Provoking, October 30, 2000

By A Customer

This review is from: Valuing Wall Street: Protecting Wealth in Turbulent Markets (Hardcover)

This is far from the dry boring stuff that is usually written on finance. The authors produce an extremely convincing and logical argument that the stock market is overvalued. This is based on comparing Tobin's q to its long term average. Tobin's q is based on flow of funds data and hence overcomes the problem of looking at corporate data. They also discuss other valuation techniques and explain their strengths and weaknesses. The book is full of interesting insights. I particularly like an example they use to demonstrate the power of compund interest. A gem of a book and well worth reading what ever your view on the state of world equity market.