The Q Ratio and Market Valuation: Monthly Update – By Doug Short

Based on the latest Flow of Funds data, the Q Ratio at the end of the first quarter was 0.96. Now, five months later, the broad market is up about 1.0%. My latest estimate would put the ratio about 38% above its arithmetic mean and 48% above its geometric mean. These numbers are very close to the levels of overvaluation at the end March, which was 37% and 47% above the arithmetic and geometric means, respectively. Of course periods of over- and under-valuation can last for many years at a time, so the Q Ratio is not a useful indicator for short-term investment timelines. This metric is more appropriate for formulating expectations for long-term market performance. As we can see in the next chart, the current level of Q has been associated with several market tops in history — the Tech Bubble being the notable exception.