Stock Market Capitalization-to-GDP Ratio

What Is the Stock Market Capitalization-to-GDP Ratio?

The stock market capitalization-to-GDP ratio is a ratio used to decide if an overall market is undervalued or overvalued compared to a historical average. The ratio can be utilized to zero in on specific markets, like the U.S. market, or it very well may be applied to the global market, contingent upon what values are utilized in the calculation. It is calculated by separating the stock market cap by gross domestic product (GDP). The stock market capitalization-to-GDP ratio is otherwise called the Buffett Indicator — after investor Warren Buffett, who promoted its utilization.

Formula and Calculation of the Stock Market Capitalization-to-GDP Ratio

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• The stock market capitalization-to-GDP ratio is a ratio used to decide if an overall market is undervalued or overvalued compared to a historical average.
• In the event that the valuation ratio falls somewhere in the range of half and 75%, the market can be supposed to be unassumingly undervalued. Likewise, the market might be fair valued assuming the ratio falls somewhere in the range of 75% and 90%, and unassumingly overvalued on the off chance that it falls inside the scope of 90 and 115%.
• The stock market capitalization-to-GDP ratio is otherwise called the Buffett Indicator — after investor Warren Buffett, who promoted its utilization.

What the Stock Market Capitalization-to-GDP Ratio Can Tell You

The utilization of the stock market capitalization-to-GDP ratio increased in unmistakable quality after Warren Buffett once remarked that it was "likely the best single measure of where valuations stand out of the blue."

It is a measure of the total value of all publicly traded stocks in a market partitioned by that economy's gross domestic product (GDP). The ratio compares the value of all stocks at an aggregate level to the value of the nation's total output. The aftereffect of this calculation is the percentage of GDP that addresses stock market value.

To compute the total value of all publicly traded stocks in the U.S., most analysts use The Wilshire 5000 Total Market Index, which is an index that addresses the value of all stocks in the U.S. markets. The quarterly GDP is utilized as the denominator in the ratio calculation.

Typically, an outcome that is greater than 100% is said to show that the market is overvalued, while a value of around half, which is close to the historical average for the U.S. market, is said to show undervaluation. Assuming the valuation ratio falls somewhere in the range of half and 75%, the market can be supposed to be unobtrusively undervalued.

Additionally, the market might be fair valued in the event that the ratio falls somewhere in the range of 75% and 90%, and unobtrusively overvalued assuming it falls inside the scope of 90% and 115%. In recent years, notwithstanding, figuring out which percentage level is accurate in showing undervaluation and overvaluation has been very controversial, given that the ratio has been trending higher over a long period of time.

The market cap to the global GDP ratio can likewise be calculated rather than the ratio for a specific market. The World Bank releases data on the Stock Market Capitalization to GDP for World which was 92% in 2018.

This market cap to GDP ratio is affected by trends in the initial public offering (IPO) market and the percentage of companies that are publicly traded compared to those that are private. All else being equivalent, assuming there was a large increase in the percentage of companies that are public versus private, the market cap to GDP ratio would go up, even however nothing has really impacted according to a valuation point of view.

Illustration of How to Use the Stock Market Capitalization to GDP Ratio

As a historical model, we should work out the market cap to the U.S. GDP ratio for the quarter ended September 30, 2017. The total market value of the stock market, as measured by Wilshire 5000, was $26.1 trillion. U.S. real GDP for the second from last quarter was recorded as $17.2 trillion. The market cap to GDP ratio is, consequently:
$\begin &\text = \frac{ $26.1 \text }{ $17.2 \text } \times 100 = 151.7$
In this case, 151.7% of GDP addresses the overall stock market value and demonstrates it is overvalued.

In 2000, as per statistics at The World Bank, the market cap to GDP ratio for the U.S. was 153%, again an indication of an overvalued market. With the U.S. market falling strongly after the dotcom bubble burst, this ratio might have some predictive value in signaling tops in the market.

Nonetheless, in 2003, the ratio was around 130%, which was as yet overvalued, however the market proceeded to create all-time highs throughout the next couple of years. Starting around 2020, the ratio remains at generally 150%.