Rational Pessimism: Predicting Equity Returns using Tobin's q and Price/Earnings Ratios

Matthew Harney and Edward Tower

No 02-29, Working Papers from Duke University, Department of Economics

Abstract: In the spring of 2000, two books predicted a substantial fall in the S&P500 Index. Robert Shiller's Irrational Exuberance found that, historically, a high price earnings ratio, with real earnings averaged over 10 years, accurately predicts a low real rate of return from investing in the S&P500 Index. Smithers and Wright's Valuing Wall Street found that a high Tobin's q for the non-financial equities in the S&P500 does the same. We discover that q beats all variants of the PE ratio for predicting real rates of return over alternative horizons. We also formalize the feedback mechanisms considered in both books.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-cfn, nep-fmk and nep-mac
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