Market Cap to GDP = Overvalued Market… Not Necessarily

Wednesday, May 10, 2017 |

The market is way overvalued!  At least according to the Corporate Equities to GDP ratio (a long-term valuation metric that takes the Balance Sheet size of public companies and divides that by GDP), which Warren Buffet once called it his favorite valuation indicator.  In fact, this is reading the second highest only to the tech bubble in 2000, and higher than the 2007 market peak.

What might be considered frightening requires a deeper dive because it doesn’t tell the whole story:

  • Over time, US companies have increased their foreign revenue (roughly 50%, per S&P Dow Jones Indices).  GDP is a domestic indicator.  Thus, the metric takes a global index and compares it to a US metric.
  • Likely related to the above, the index has increased over time and the trend is up.  Using valuation averages starting from 1950 likely isn’t a good way to determine over/under valuation.
  • Long-term valuation metrics tell you nothing about what will happen in the next few years.  This particular one has been extremely overvalued since about 2014, all the while stocks have powered higher.

The above counter points don’t mean the market is cheap.  We forecast below average returns (though still positive) over the next 7 to 10 years.  However, they do show how metrics change over time and that reliance on too few can lead to faulty assumptions.  For example, we utilize Market Cap to GDP in our forecasts, but take into account the metric has increased over time and use it in concert with other long-term valuations metrics.


Chart Source: Advisor Perspectives

S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market.  Investors cannot invest directly in an index.

Past performance is no guarantee of future results.

Gross Domestic Product (GDP) is a measure of output from U.S factories and related consumption in the United States.  It does not include products made by U.S. companies in foreign markets.

Market capitalization refers the total dollar market value of a company's outstanding shares. Commonly referred to as "market cap," it is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to using sales or total asset figures.

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