This ratio was
last brought up in October in a post using "Buffett's approach" to macroeconomics. He said:
On a macro basis, quantification doesn't have to be complicated at all. Below is a chart, starting almost 80 years ago and really quite fundamental in what it says. The chart shows the market value of all publicly traded securities as a percentage of the country's business--that is, as a percentage of GNP. The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment.
Below is an updated chart of the ratio from
Fairfax's annual meeting slides:
The post shows the ratio near levels of 110% at the beginning of 2008. Since then, GDP has remained essentially flat, while the S&P500 is down 11%. So, that puts the ratio at approximately 98% today.
The post shows the ratio near levels of 110% at the beginning of 2008. Since then, GDP has remained essentially flat, while the S&P500 is down 11%. So, that puts the ratio at approximately 98% today.
11 comments:
This chart is very similar to historical P/E. If so, I think that it should be compared in the context of interest rate. Low P/E can justify high MarketCap(Price)/GDP.
The last sentence should be Low interest rate can justify high MarketCap(Price)/GDP.
Yes, but in that case one would also have to lower their expected rate of return. If you are buying an index of stocks with an earnings yield of 4%, it is very difficult to imagine returns being meaningfully above 4%. Earnings could grow from either 1)GDP growth, or 2) increased corporate profits as a % of GDP. Stock market returns can also increase if interest rates move lower.
But let's imagine rates now fall to 2%- is it right to justify a stock market level that is twice as high as before? I think the answer is only if the buyers at the new level are willing to accept an approximately 2% rate of return going forward.
2% is the expected return in bond market for a given maturity, not the expected return for stock market. My main point is that the inter-relationship between stocks and bonds may be more relevant than the historical market cap/GDP ratio levels or historical P/E ratio.
Not true. If you are buying an S&P500 index with an earning yield of 2%, and lets say you invest 100 dollars into it. Year 1, you can expect $2 returned to you for your investment. Going forward,that yield will grow based on 2 factors: nominal GDP growth, and corporate profits as a % of GDP. That's the only way it works when we are speaking about US companies as a whole. So let's say 4% GDP growth and corporate profits as a % of GDP stays the same. First year you'll have $2 in earnings, second year will be $2.08, and so on. Still, you'll find out your overall stock market returns will still be near 2%, unless participants want to boost valuations and so offer even lower future returns for the next set of investors.
Great analysis, but I think we are missing the word global. With a global analysis we are getting a third source of growth in earnings: increased corporate profit of the US listed companies as a percent of global corporate profits. Note that the chart broke out to upside when "internationalization" became the hottest theme of corporate USA.
That is definitely having an effect. It is also encouraging that the ratio is back down to the 70-80% range now.
I like the discussion and chart you have here...however, the 60% historical # is not wholly accurate. The value of stocks was not fully realized in comparison to bonds until after John Burr Williams and Ben Graham. Buffett and many other value investors have used the 85% rule in comparison to GNP. Technically, full value is about 100% since profit margin is about 5% for businesses. AAA bonds are about 6.75% long term. This is what Buffett uses as a discount rate when valuing Washington Post in several articles. This means EBIT/(Enterprise Value+LT Bonds+Pension) should =6.75%. Bonds don't have growth, which stocks as a whole get at the same growth rate to GNP. If you can buy a stock long term that meets the EBIT/ Enterprise Value that doesn't need much for CAPEX (hopefully none) and still grows with GDP you will do well.One more thing when Wilshire 5000/GNP=.70, the market historically is fairly priced since 1970. If it is cheaper load up. This info should be easy to find on Yahoo Finance etc. Market is currently hovering around .60, which would seem low except GDP will likely be negative instead of 5% positive this year. So market is probably fairly valued at 850-900 S&P. This number should increase at same rate as GNP growth.
I think the market cap should price in already the attractiveness of earning yield over bond yield during a period of cheap valuation. However, the rationale of LOW market cap to GNP ratio is that the systematic risk is taking a bigger role in valuation wise rather than non systematic risk. In other words, during that period, the market conditions dictates more than the specific company management in respect to the company's performance and its likelyhood to survive. For example, even the best run company will experience difficulty during the macro's onslaught. So top down approach is more effective than bottom up approach in this condition.
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