What Is the Stock Market Capitalization-to-GDP Ratio?
Let me explain the stock market capitalization-to-GDP ratio, which you might know as the Buffett Indicator. It's a straightforward measure to check if a market is undervalued or overvalued against historical benchmarks. You get this by dividing the total market cap by the country's GDP, and it gives you valuable insights for your investment decisions.
Key Takeaways
You should note that this ratio, the Buffett Indicator, determines if a market is overvalued or undervalued compared to historical averages. If it's below 75%, the market looks undervalued, but above 115%, it's likely overvalued. To calculate it, divide the total market value of publicly traded stocks by GDP, and for the U.S., analysts often use the Wilshire 5000. Keep in mind, though, that its accuracy is debated because economic factors and market trends can influence it.
How to Calculate the Stock Market Capitalization-to-GDP Ratio
Calculating this is simple: the formula is Market Capitalization to GDP equals Stock Market Capitalization divided by GDP, multiplied by 100. Here, SMC stands for Stock Market Capitalization, and GDP is Gross Domestic Product. You can think of it as a percentage that shows how the stock market's value stacks up against the economy's output.
Insights From the Stock Market Capitalization-to-GDP Ratio
Warren Buffett once said this ratio is probably the best single measure of valuations at any moment, which is why it gained prominence. It measures the total value of all publicly traded stocks divided by the economy's GDP, comparing aggregate stock values to total output, resulting in a percentage of GDP that the stock market represents.
For the U.S., you typically use the Wilshire 5000 Total Market Index for stock values and quarterly GDP as the denominator. A ratio over 100% suggests overvaluation, while around 50%—the historical U.S. average—indicates undervaluation. Between 50% and 75%, it's modestly undervalued; 75% to 90% means fair value; and 90% to 115% shows modest overvaluation.
In recent years, there's been debate on these levels because the ratio has trended higher over time. You can also calculate it globally using World Bank data on stock market cap to global GDP. Factors like IPO trends and the share of public versus private companies affect it—if more companies go public, the ratio rises even without real valuation changes.
Practical Example: Applying the Stock Market Capitalization-to-GDP Ratio
Take the quarter ended September 30, 2017, as an example. The Wilshire 5000 showed a total market value of $26.1 trillion, and U.S. real GDP was $17.2 trillion. So, the ratio is $26.1 trillion divided by $17.2 trillion, times 100, which equals 151.7%. That means 151.7% of GDP was stock market value, pointing to overvaluation.
Back in 2000, the U.S. ratio was 153% according to World Bank stats, signaling overvaluation before the dotcom bubble burst, which suggests some predictive value for market peaks. But in 2003, at around 130%—still overvalued—the market later hit all-time highs. As of 2020, it's about 150%.
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