Finding the Missing Link Between Stocks and GDP

Unfortunately, we can't put Tobin's Q on our quote screens. The New York Stock Exchange stopped publishing daily market capitalization data last November; the Nasdaq still publishes such a number. The sum of these two at the end of May was $12.1 trillion. But these include only listed stocks, and, therefore, ignore other measures of investment capital. The replacement costs of all real capital assets is a lagging book-value measure, whose only virtue may lie in its consistency. The ratio of the two would arrive too late to be of use to anyone.

We can depict the mechanisms of Tobin's Q by taking the ratio of total capital expenditures to GDP and comparing it to our residual series. At the late-1970s trough in the residual series, a period corresponding to a low current return on financial assets, investment in real plant and equipment was high. After 1994, however, stock prices and capital investment rose and fell concurrently. The paper assets representing existing capital stock and investment in new and presumably more-efficient capital stock rose and fell together instead of opposite one another.

Usual Suspect Number Two: Capital Investment

Source: Bloomberg

Such have-our-cake-and-eat-it-too behavior could be justified if after-tax corporate profits were rising as a percentage of GDP. They were, and significantly so, from 1986 through the onset of the Asian crisis at the end of the third quarter in 1997. But the loss of global customers and the cannibalistic competition from new domestic investment lowered this profitability precipitously, all the way until the end of the first quarter of 2002, the very time at which the bottom dropped out of stocks.

Usual Suspect Number Three: Corporate Profits

Source: Bloomberg