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What is the Q ratio?

Economists take one of two positions on how to value the market as a whole.

The earnings yield/bond yield ratio is based on the assumption that the prospective earnings yield should equal the yield on government bonds. Support for this position comes from a paper by US Federal Reserve economists that highlighted the usefulness of the ratio as a market timing device between 1978 and 1996. Adherents of the alternative position believe that the factors such as lower inflation and lower economic growth that cause bond yields to fall will also bring down expectations of profit growth. Bond yields, they say, are therefore irrelevant to equity valuations. One of the measures used by this school of thought is the Q ratio, that is the relationship between stock market value and the replacement cost of the corporate sector’s net assets. The theory is that when the market is valued at more than asset value (when Q is more than one), then it will make sense for the corporate sector to invest more.