The Library of Mistakes Ep 5: The Economics of the Stock Market (with Andrew Smithers)
May 20, 2022
Andrew Smithers, economist and long-time market practitioner known for his work on valuation, discusses corporate net worth versus market value. He debates why consensus Q theory is flawed. He explores how high Q can destabilize economies, the role of central bank policy in inflating market values, and incentives that push managers toward short-termism.
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Decades Of Market Experience Inform The Argument
- Andrew Smithers began trading as a schoolboy in the 1950s and later ran SG Warburg's asset management business.
- His decades of market experience inform his critique of theory versus practice throughout the book.
Market Valuation Drives Investment Decisions
- Stock market valuations, not accounting net worth, drive managers' and investors' decisions.
- Net worth measures (second-hand equipment value) diverge from market value, so Q can rise without matching capital stock increases.
High Q Is Fragile And Amplified By QE
- The Q ratio is mean-reverting and tends to fall faster than it rises, making high Q levels dangerous.
- Excessively low interest rates and quantitative easing inflate stock market value while net worth barely changes, increasing crash vulnerability.