In 2001, Warren Buffett wrote an article in Fortune. Among other things, he discussed the relationship between GNP and the market cap of domestically traded companies in terms of when stocks in general are good investments:

"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. And as you can see, nearly two years ago the ratio rose to an unprecedented level. That should have been a very strong warning signal.

For investors to gain wealth at a rate that exceeds the growth of U.S. business, the percentage relationship line on the chart must keep going up and up. If GNP is going to grow 5% a year and you want market values to go up 10%, then you need to have the line go straight off the top of the chart. That won't happen.

For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire. As you can see, the ratio was recently 133%."

Currently, GDP and the market cap of the Wilshire 5000 (basically all publicly traded domestic companies) are both slightly more than $14 Trillion.

So, that relationship Buffett wrote about is now 1:1. In 1999, market cap was at a 2:1 ratio to GDP. By 2001, it was 1.3:1. Now it's 1:1. According to Buffett's review of 80 years of history (and I don't have the chart he mentioned, unfortunately), market cap has to fall to 70-80% of GDP before stocks in general are a screaming buy.

In other words, we have a ways to go.

interesting good find

What makes you think for sure that stocks are going to become so depressed they are a "screaming buy" before they go back up? The conclusion you are drawing is ******ed.

I guess me and Buffett are ******s. Who TF are you?

Tell me this - had you even thought about the GDP-market cap relationship before you read this post? If not, then I guess you learned something.

BTW Buffett also wrote about 17 year stock market cycles. You might want to read his article that I linked.

If you think that 2008 marks the bottom, with a 1:1 GDP:market cap ratio 8 years into what historically is a 17 year cycle with interest rates yet to wreak any havoc on stock prices, then by all means load up on SPY. Buy and hold you some DIA.

As for me, I'll wait.

Interesting information and a good read, but there's no reason to attack him for asking a question about it. Its a valid counterpoint imo. Just because valuation could fall farther and you have an expected buying point, certainly doesn't mean prices will actually reach such levels.

Yeah, I may have been too harsh. But I didn't read his question as legitimate. I thought it was rhetorical, given his "******ed" comment.

Everybody knows that past performance is no guarantee of future results. Whether you are looking at an 80 minute chart or an 80 year chart.

On the other hand, those who refuse to learn from history are doomed, and I thought people would be interested in Buffett's historical insights and conclusions re: stock market valuation.

Wow! The guy just said he needs to see stocks lower before he considers them a screaming buy and shows in DETAIL why and you think that is ******ed? Let's see you post something that is not ******ed.

Binions that was an EXCELLENT post and I thank you for it!!! There is so much investment noise out there it is very productive to have a big picture long term mentality.

answer is mad cuz his account is getting smashed every day

FYI:

http://bp0.blogger.com/_BTyVSDdxyc0/...ion+to+GDP.bmp

Thanks - scroll down to page 10 of 11 for the chart used in Buffett's 2001 article:

I think what Answer Anderstood is asking, is why do stocks have to become screaming buys? Couldn't we go the next 100+ years above 80%? Is a 1:2 ratio impossible? What happens if we get a 'screaming buy' and the GDP falls 25%? Can I buy now and just have the GDP catch up?

I think it's interesting, but I can't see how this could translate into a strategy or a way to make money. Just a way for the brain to try and connect the dots after the fact.

Interesting post, although I wonder what impact historical loosening of international capital flows (i.e. liquidity) would have on this? Would this relationship hold true for all markets and economies or do different ones have a different equilibrium such as this?

Can someone explain to me why market cap shouldn't be higher than the gross domestic product?

i can't think of a good reason. it seems like a rule of thumb based on historical data.

it seems like, at a given point in time there should be an approximate relationship between market cap and gpd based on interest rate, the growth rate of the economy, the percent of economic activity done by public companies, etc. but since all of these can change, it doesn't seem like we can use a a fixed ratio of market cap to gdp to evaluate whether stocks as a whole are overvalued.

ok good, because I know that I don't know much about finance but I couldn't figure out any reason why these two things should be directly related outside of growth rate.

Newbie question here...

What's the difference between the wilkshire 5000 index and the wilkshire 5000 index market cap?

Is there a site that shows the value of international stock indexes similar to the wilkshire 5000 that can be compared to other countries GDPs?

Thanks in advance.

$1B/point.

This was a good bump, by the way. Interesting to see what people's thought are now that the market has had a bit of a crash subsequent to the OP.

Doesn't the Wilkshire index have adjustments made to it? From the charts on the Wilkshire Web Site, it appears that the index value (x1B) is slightly lower than the market cap.

Sept. 30 2008 =
1. Total Market Value ($) = $12.8T
2. Total Market Value ($)- Full Cap = $14.05T
3. Dow Jones Wilkshire 5000 Composite Index x 1B = approx. $11.8T

Which value do we use to compare to to the GDP?

Use the full cap, it counts all shares including those not available for trading. It's down 24% since September 30 so that means we're at $14.05T * 0.76 = $10.7T.

there is also some academic literature with similar implications. the so called wealth/consumption ratio is a good predictor of stock returns in the following years empirically. a depressed wealth/consumption ratio indicates better returns in the future.

Current Wilshire 5000 Total Cap = $10.51T
Current GDP = $14.4T

Now 73%! Down to the 70-80% area Buffet mentioned in 2001!

for the theory to work one of the two benchmarks needs to be accurate relative to fundamentals providing an opportunity to arbitrage the non-fundamentally driven measure. unfortunately neither are accurate right now. if even we assume one is, how do we know its gdp that isnt over valued rather than stocks being undervalued.

Don't mistake me for advocating buying stocks now that market cap is 73% of GDP.

Market cap can stay under 100% of GDP for years. It will probably take the next long term bull market to hoist it above 100%, like what happened from 1982 to 1999.

Just making an observation of the relationship in the context of Buffett's article.

Isn't it also interesting that the Dow:Gold ratio is down to 10 from a high of 45 back in 1999. Historically, the ratio has fallen to a range from 1-5 at the end of long term stock bear markets, with 1980 seeing a 1:1 ratio for a few days.

Now, if the ratio continues to fall, that doesn't tell you if gold will rise or stocks will fall or a little of each. Nor can you be certain the ratio will continue to fall. Just another observation of interest to me.

Can someone please explain what this graph means?

market cap = value of all businesses

gnp = value of what those business produce each year

So basically, according to this graph: http://bp0.blogger.com/_BTyVSDdxyc0/...ion+to+GDP.bmp if the United States consisted of a single wedge company, and the company had a market cap of $59.6 and they produce $100 worth of goods, that would be average?