Market Cap to GDP is a long-term valuation indicator for stocks. It has become popular in recent years, thanks to
Warren Buffett. Back in 2001 he remarked in a Fortune
Magazine interview that "it is probably the best single measure of where valuations stand at any given
'Market Cap to GDP' is commonly defined as a measure of the total value of all publicly-traded stocks in a country, divided by that country’s Gross Domestic Product.
The ratio in the chart above is calculated by dividing the 'Wilshire 5000 Total Market Index' by the US GDP. The Wilshire 5000 is widely accepted as the definitive benchmark for the US equity market and is intended to measure the total market capitalization of all US equity securities with readily available price data.
In contrast to the Wilshire 5000, the numerator in the chart above includes the total value of public and private equities. However, it only gets published quarterly and therefore is always lagging a bit behind. On the upside, it has data going back to the 1940s, thereby providing a more historical perspective.
In contrast to the Wilshire 5000, the Dow Jones only contains 30 publicly traded companies. The index is price-weighted, so stocks with a higher share price are given greater weight. For these reasons, it is not as accurate as the Wilshire 5000 for measuring the market capitalization. However, all these ratios look very similar - and since some calculations for the Dow Jones go back to 1790, this ratio provides an interesting historical perspective.
For comparison purposes the S&P 500 to GDP ratio is shown here as well. The S&P
500 consists of 500 large US companies. Just like the Wilshire 5000, it is a capitalization-weighted Index. It captures approximately 80% of the available total market
For these reasons, it's a much better measure for 'market cap' than the Dow Jones.
Update: Since 1971, the S&P 500 performed almost identically to the Wilshire 5000. However, the S&P 500 is still just a proxy for the total value of all US publicly-traded equities and over the long-term it performed differently. According to this paper (page A56), the US market cap to gdp ratio in the late 1800's was around 50%, which is a third of what it was during the Dot-com bubble of 2000.
As mentioned above, the S&P 500 captures approximately 80% of available market capitalization. Therefore it is quite representative of the entire stock market. Intuitively, the stock market and the overall economy should grow with a similar pace.
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