"Rational Pessimism: Predicting Equity Returns by Tobin's q and Price/Earnings Ratios"
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.
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