The Buffett Indicator, also known as Market Cap to GDP, has gained prominence as a long-term valuation indicator for stocks, largely due to Warren Buffett's endorsement. In a Fortune Magazine interview back in 2001, Buffett referred to it as "probably the best single measure of where valuations stand at any given moment." This statement has drawn attention to the indicator's potential significance in assessing market conditions. The calculation of the Buffett Indicator involves dividing the total market value of all publicly-traded stocks within a country by the country's Gross Domestic Product (GDP). By comparing the stock market's size to the overall economic output, this ratio provides insights into the relative valuation of the market. To illustrate this concept, one common approach is to examine the ratio between the Wilshire 5000 and the GDP of the United States. The Wilshire 5000 is widely regarded as the definitive benchmark for the US equity market, aiming to measure the total market capitalization of all US equity securities with readily available price data. By dividing this market index by the GDP, we can obtain a snapshot of the market's valuation in relation to the country's economic performance.
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.
Similar to the Buffett Indicator, the Dow Jones to GDP ratio provides insights into the relative valuation of the stock market compared to the size of the economy. 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.
The S&P 500 to GDP ratio, like the Buffett Indicator, assesses the stock market's valuation relative to the economy. However, it specifically considers the market capitalization of the 500 companies in the index, while the Buffett Indicator covers all publicly traded stocks. The S&P 500 ratio offers a narrower view, focusing on large-cap companies, while the Buffett Indicator provides a broader perspective of the entire market, including smaller-cap stocks and companies outside the S&P 500.
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 the S&P 500 to GDP ratio deviated from the Buffett indicator. 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.
Just like the Wilshire 5000, the S&P 500 is a capitalization-weighted Index. It captures approximately 80% of the available total 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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