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Buffett Indicator: Strongly Overvalued

Updated for August 6, 2020

Overview

The Buffett Indicator is the ratio of total US stock market valuation to GDP. By our calculation it is currently 64% higher than the historical average, suggesting that the market is Strongly Overvalued. It has not been at this level since the Internet Bubble of the early 2000's. The historical chart of this indicator is shown below - for more analysis and information on our data sources and methodology, keep reading.

Market Value to GDP

Theory & Data

Total Market Value

The theoretical value of any single share of stock is the present value of future cash flows attributable to that share. In aggregate, the combined value (market capitalization) of the full US stock market represents the present value of all future economic profits by public corporations. This is not so much a measure of current valuation as it is an indicator of future expectations. If the value of the whole stock market goes up, it is because investors think that future profits are going to increase.

The most common measurement of the aggregate value of the US stock market is the Wilshire 5000. This is available directly from Wilshire, with monthly data starting in 1971, and daily measures beginning in 1980. (In fact, today it is updated every second, but we use daily closing value here). The Wilshire index was created such that a 1-point increase in the index corresponds to a $1 billion increase in US market cap. Since inception, that 1:1 ratio has drifted, and as of Dec 2013 a 1-point increase in the index corresponded to a $1.15 billion dollar increase. We adjust the data back to inception (and projected going forward) on a straight-line basis to compensate for this drift.

For data prior to 1970 we use the Z.1 Financial Account - Nonfinancial corporate business; corporate equities; liability, Level, published by the Federal Reserve, which provides a quarterly estimate of total market value back from 1945. In order to integrate the datasets, we index the Z.1 data to match up to the 1970 Wilshire starting point.

Combined, these data make our Composite US Stock Market Value data series, shown below.


Figure 1. Total Composite Market Value
Total Composite Market Value
GDP

The GDP represents the total production of the US economy. This is measured quarterly by the US Government's Bureau of Economic Analysis. The GDP is a static measurement of prior economic activity - it does not forecast the future or include any expectation or valuation of future economic activity. The GDP is calculated and published quarterly, but unfortunately it is done several months in arrears, such that by the time the data is published it is several months old. In order to provide updated data for the most recent quarter we use the most recent GDPNow estimate published by the Federal Reserve Bank of Atlanta. The GDP data is all nominal and not inflation adjusted. It is shown below.


Figure 2. Nominal Quarterly GDP
Nominal Quarterly GDP
The Ratio of the Two

Given that the stock market represents primarily expectations of future economic activity, and the GDP is a measure of most recent economic activity, the ratio of these two data series represents expected future growth relative to current performance. This is similar in nature to how we think about the PE ratio of a particular stock. [Note - there are many different market valuation indicators in this same vein, many of which we may eventually incorporate into our total model]. It stands to reason that this ratio would remain relatively stable over time, and increase slowly as technology increases.

Current Values & Analysis

The historic ratio of market value to GDP can be seen below.


Figure 3. Total Market Value to GDP
Market Value to GDP

In the chart above, the exponential regression line shows the natural growth rate of the indicator. This shows the upward historical trend that expectations for future growth have risen faster over time than actual economic output. This makes sense, as technological progress drives exponential returns.

Detrending

To make the context of our current position more clear, we can draw the regression line horizontally and remap the data as the percentage above our below that historical average. This is shown below, along with band lines showing +/- a standard deviation.


Figure 4. Total Market Value to GDP - Detrended w/Std Dev
Market Value to GDP

And finally, below is the same chart, but with only the last twenty years of data, so that recent market activity can be seen more clearly.


Figure 5. Total Market Value to GDP - Detrended w/Std Dev - Recent
Market Value to GDP - Recent
Summary

The current market-to-GDP ratio is 64% above the historical average, and considered Strongly Overvalued (see our ratings guide for more information).


Data Sources

The below table cites all data and sources used in constructing the charts, or otherwise referred to, on this page.

Item Source
Z.1 Financial Account Board of Governors of the Federal Reserve System (US), Nonfinancial corporate business; corporate equities; liability, Level [NCBEILQ027S], retrieved from FRED, Federal Reserve Bank of St. Louis
Wilshire 5000 Wilshire 5000, with proprietary adjustments to index data.
GDP U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis;
GDP Now GDPNow - Federal Reserve Bank of Atlanta, estimate of current quarter GDP.