I have to take my hat off to Barron’s columnist Alan Abelson, long-time writer of the column “Up and Down Wall Street.” If I lived in a bear den, as he must, I would probably be just as pessimistic; yet I find a certain perverse pleasure in reading his column and partaking of his acerbic comments.

I can rationalize reading Abelson with such relish as a way to keep my normally optimistic self grounded in the fact that there are others who see the glass half-empty against my half-full.
Each week, Abelson seems to find some facet of the financial world to skewer with his wit and cynicism. He also seems to find someone with a theory that calls into question anything approaching “irrational exuberance.” This past week’s column did both.

First, he took on President Bush for his lack of candor in dealing with economic matters. In this case, I agree with him. Instead of skirting the issues, Bush needs to make it clear that he and his administration did not cause the recession or the flabbiness of the economy. They inherited a bubble that was bursting from too much capital spending by business—something that will take a while to work its way through the system.

By defensively talking around the real issues of the economy, Bush begins to invoke an aversion to truth and reality—not a good trait for a President soon to seek reelection! Personally, I would like him to plainly confront the deficit issue: just say we’re going to be printing money for awhile, so we should get used to it. We can also stand the truth when it comes to the price tag for fixing the economy and, while we are at it, Iraq.

Just so the rising stock market doesn’t get everyone too excited, Abelson interviewed analyst Andrew Smithers of the London firm of Smithers & Co. Smithers and partner Stephen Wright just published a report with the catchy title, The Real Bear Market Hasn’t Happened Yet. Smithers is fond of using the Q ratio theories developed by the late James Tobin, a Nobel laureate from Yale. Tobin’s Q ratio is the total value of the stock market divided by corporate net assets at replacement cost. If the market is overvalued, the Q ratio will be greater than one, with the reverse being true for an undervalued market.

Smithers and Young are not ready to call an end to this bear market. They believe that bear markets end when prospective returns are significantly above their historic average. According to their analysis, despite the slide of the past three years, market returns are still overvalued.
Part of the overvaluation was caused by massive corporate share repurchases. This was simply a transfer of corporate assets to shareholders. Applying that to the Q ratio, the resulting reduction in corporate replacement values reduces the denominator in the ratio, and increases the ratio—or overvaluation assumptions.

Our friends from London argue that at its peak, the market was three times overvalued. Despite the fact that the market drop from the high has wiped away one-third of that overvaluation, we still have another third to go before fair value levels are reached. And, if that isn’t enough to get your attention, they point out that for the market to get back to “cheap as it was in 1974,” we would need to knock 60% off the current value.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.