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

  • Harney, Matthew
  • Tower, Edward

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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Paper provided by Duke University, Department of Economics in its series Working Papers with number 02-29.

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Date of creation: 2002
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Publication status: Forthcoming in THE JOURNAL OF INVESTING
Handle: RePEc:duk:dukeec:02-29
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