Market Cap To GDP: The Buffett Valuation Indicator
Doug Short | Oct 10, 2014 01:40AM ET
Note from dshort: I've updated this commentary at the request of my good friend and master market technician Chris Kimble of Fortune Magazine interview that "it is probably the best single measure of where valuations stand at any given moment."
Get The News You Want
The four valuation indicators I track in my monthly valuation overview offer a long-term perspective of well over a century. The raw data for the "Buffett indicator" only goes back as far as the middle of the 20th century. Quarterly GDP dates from 1947, and the Fed's B.102 Balance sheet has quarterly updates beginning in Q4 1951. With an acknowledgement of this abbreviated timeframe, let's take a look at the plain vanilla quarterly ratio with no effort to interpolate monthly data.
Get The News You Want
Get The News You Want
The strange numerator in the chart title, Q Ratio valuation indicator.
Get The News You Want
Get The News You Want
The numerator is from the Fed's Q2 Z.1 Financial Accounts released on September 18th. I've updated the GDP denominator with the Q2 Third Estimate.
Get The News You Want
Get The News You Want
WILL5000PRFC ).
Get The News You Want
Get The News You Want
A quick technical note: To match the quarterly intervals of GDP, for the Wilshire data I've used the quarterly average of daily closes rather than quarterly closes (slightly smoothing the volatility).
Get The News You Want
Get The News You Want
How Well do the Two Views Match?
Get The News You Want
Get The News You Want
The first of the two charts above appears to show a significantly greater overvaluation. Here are the two versions side-by-side. The one on the left shows the latest valuation over two standard deviations (SD) above the mean. The other one is noticeably lower. Why does one look so much more expensive than the other?
Get The News You Want
|
|
|
Get The News You Want
One uses Fed data back to the middle of the last century for the numerator, the other uses the Wilshire 5000, the data for which only goes back to 1971. The Wilshire is the more familiar numerator, but the Fed data gives us a longer timeframe. And those early decades, when the ratio was substantially lower, have definitely impacted the mean and SDs.
Get The News You Want
Get The News You Want
To illustrate my point, here is an overlay of the two versions over the same timeframe. The one with the Fed numerator has a tad more upside volatility, but they're singing pretty much in harmony.
Get The News You Want
Get The News You Want
Wilshire 5000 currently consists of fewer than 4000 companies.
Get The News You Want
Get The News You Want
What Do These Charts Tell Us?
Get The News You Want
Get The News You Want
In a CNBC interview earlier this spring CNBC interview (April 23rd), Warren Buffett expressed his view that stocks aren't "too frothy". However, both the "Buffett Index" and the Wilshire 5000 variant suggest that today's market is indeed at lofty valuations, now above the housing-bubble peak in 2007. In fact, the more timely of the two (Wilshire / GDP) has risen for eight consecutive quarters and is now approaching two standard deviations above its mean -- a level exceeded for six quarters during the dot.com bubble.
Get The News You Want
Get The News You Want
Wouldn't GNP Give a More Accurate Picture?
Get The News You Want
Get The News You Want
That is a question I've been asked mutiple times. Here is the same calculation with Gross National Product as the denominator; the two versions differ very little from their Gross Domestic Product counterparts.
Get The News You Want
|
|
|
Get The News You Want
Here is an overlay of the two GNP versions -- again, very similar.
Get The News You Want
Get The News You Want
four valuation indicators I update monthly. I've not included it for various reasons: The timeframe is so much shorter, the overlapping timeframe tells the same story, and the four-version overlay is about as visually "busy" as I'm comfortable graphing.
Get The News You Want
Get The News You Want
One final comment: While I see this indicator as a general gauge of market valuation, it it's not useful for short-term market timing, as this overlay with the S&P 500 makes clear.
Get The News You Want
Get The News You Want
Get The News You Want
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.