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Total Market Cap and US GDP

The Ratio of Total Market Cap to US GDP

The Predicted and the Actual Stock Market Returns

2014-04-20:
The Stock Market is Significantly Overvalued. Based on historical ratio of total market cap over GDP (currently at 116%), it is likely to return 1.8% a year from this level of valuation. This page is updated daily with the market.



New: Shiller P/E, also Global Market Valuation: Germany, France, UK, China, India etc.

What returns can we expect from the stock market?

As of today, the Total Market Index is at $ 19832.2 billion, which is about 116% of the last reported GDP. The US stock market is positioned for an average annualized return of 1.8%, estimated from the historical valuations of the stock market. This includes the returns from the dividends, currently yielding at 2%.

As pointed by Warren Buffett, the percentage of total market cap (TMC) relative to the US GNP is “probably the best single measure of where valuations stand at any given moment.”

Over the long term, the returns from stock market are determined by these factors:

1. Interest rate

Interest rates “act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That's because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward.”—Warren Buffett

2. Long Term Growth of Corporate Profitability

Over the long term, corporate profitability reverts to its long term-trend, which is around 6%. During recessions, corporate profit margins shrink, and during economic growth periods, corporate profit margins expand. However, long-term growth of corporate profitability is close to long-term economic growth. The size of the US economy is measured by Gross National Product (GNP). Although GNP is different from GDP (gross domestic product), the two numbers have always been within 1% of each other. For the purpose of calculation, GDP is used here. The U.S. GDP since 1970 is represented by the green line in the first of the three charts to the right.

3. Market Valuations

Over the long run, stock market valuation reverts to its mean. A higher current valuation certainly correlates with lower long-term returns in the future. On the other hand, a lower current valuation level correlates with a higher long-term return. The total market valuation is measured by the ratio of total market cap (TMC) to GNP -- the equation representing Warren Buffett's "best single measure". This ratio since 1970 is shown in the second chart to the right. Gurufocus.com calculates and updates this ratio daily. As of 04/20/2014, this ratio is 116%.

We can see that, during the past four decades, the TMC/GNP ratio has varied within a very wide range. The lowest point was about 35% in the previous deep recession of 1982, while the highest point was 148% during the tech bubble in 2000. The market went from extremely undervalued in 1982 to extremely overvalued in 2000.

Based on these historical valuations, we have divided market valuation into five zones:

Ratio = Total Market Cap / GDP Valuation
Ratio < 50% Significantly Undervalued
50% < Ratio < 75% Modestly Undervalued
75% < Ratio < 90% Fair Valued
90% < Ratio < 115% Modestly Overvalued
Ratio > 115% Significantly Overvalued
Where are we today (04/20/2014)? Ratio = 116%, Significantly Overvalued

A quick refresher (Thanks to Greenbacked): GDP is “the total market value of goods and services produced within the borders of a country.” GNP is “is the total market value of goods and services produced by the residents of a country, even if they’re living abroad. So if a U.S. resident earns money from an investment overseas, that value would be included in GNP (but not GDP).” While the distinction between the two is important because American firms are increasing the amount of business they do internationally, the actual difference between GNP and GDP is minimal as this chart from the St Louis Fed demonstrates:

GDP vs. GNP

GDP in Q4 2012 stood at $15,851.2 billion. GNP at Q3 2012 (the last data point available) stood at $16,054.2 billion. For our present purposes, one substitutes equally as well for the other.

The Sources of Investment Returns

The returns of investing in an individual stock or in the entire stock market are determined by these three factors:

1. Business growth

If we look at a particular business, the value of the business is determined by how much money this business can make. The growth in the value of the business comes from the growth of the earnings of the business growth. This growth in the business value is reflected as the price appreciation of the company stock if the market recognizes the value, which it does, eventually.

If we look at the overall economy, the growth in the value of the entire stock market comes from the growth of corporate earnings. As we discussed above, over thelong term, corporate earnings grow as fast as the economy itself.

2. Dividends

Dividends are an important portion of the investment return. Dividends come from the cash earning of a business. Everything equal, a higher dividend payout ratio, in principle, should result in a lower growth rate. Therefore, if a company pays out dividends while still growing earnings, the dividend is an additional return for the shareholders besides the appreciation of the business value.

3. Change in the market valuation

Although the value of a business does not change overnight, its stock price often does. The market valuation is usually measured by the well-known ratios such as P/E, P/S, P/B etc. These ratios can be applied to individual businesses, as well as the overall market. The ratio Warren Buffett uses for market valuation, TMC/GNP, is equivalent to the P/S ratio of the economy.

What Returns Is the Market Likely to Deliver From This Level?

Putting all the three factors together, the return of an investment can be estimated by the following formula:

Investment Return (%) = Dividend Yield (%)+ Business Growth (%)+ Change of Valuation (%)

The first two items of the equation are straightforward. The third item can be calculated if we know the beginning and the ending market ratios of the time period (T) considered. If we assumed the beginning ratio is Rb, and the ending ratio is Re, then the contribution in the change of the valuation can be calculated from this:

(Re/Rb)(1/T)-1

The investment return is thus equal to:

Investment Return (%) = Dividend Yield (%) + Business Growth(%) + (Re/Rb)(1/T)-1

This equation is actually very close to what Dr. John Hussman uses to calculate market valuations. From this equation we can calculate the likely returns an investment in the stock market will generate over a given time period. In the calculation, the time period we used was 8 years, which is about the length of a full economic cycle. The calculated results are shown in the final chart to the right. The green line indicates the expected return if the market trends towards being undervalued (TMC/GNP=40%) over the next 8 years from current levels, the red line indicates the return if the market trends towards being overvalued (TMC/GNP=120%) over the next 8 years. The brown line indicates the return if the market trends towards being fair-valued (TMC/GNP=80%) over the next 8 years.

The thick light blue line in the bottom right chart is the actual annualized return of the stock market over 8 years. We can see the calculations largely predicted the trend in the returns of the stock market. The swing of the market’s returns is related to the change in interest rates.

It has been unfortunate for investors who entered the market after the late 1990s. Since that time, the market has nearly always been overvalued, only dropping to fairly valued since the declines that began in 2008. Since Oct. 2008, for the first time in 15 years, the market has been positioned for meaningful positive returns.

As of 04/20/2014, the stock market is likely to return 1.8% a year in the next 8 years.

Warren Buffett’s Market Calls

Based on these factors, Warren Buffett has made a few market calls in the past. In Nov. 1999, when the Dow was at 11,000, and just a few months before the burst of dotcom bubble, the stock market had gained 13% a year from 1981-1998. Warren Buffett said in a speech to friends and business leaders, “I'd like to argue that we can't come even remotely close to that 12.9... If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.”

Two years after the Nov. 1999 article, when the Dow was down to 9,000, Mr. Buffett said, “I would expect now to see long-term returns run somewhat higher, in the neighborhood of 7% after costs.”

Nine years have passed since the publication of the article of November 22, 1999, and it has been a wild and painful ride for most investors; the Dow climbed as high as 14,000 in October 2007 and retreated painfully back to 8,000 today. Warren Buffett again wrote in Oct. 2008: Equities will almost certainly outperform cash over the next decade, probably by a substantial degree.”

Related Links:

1. Warren Buffett Stock Picks
2. Buffett-Munger Screener: The stocks young Warren Buffett would buy
3. Market Valuations as measured by Shiller P/E ratio

 

 

Add Notes, Comments or Ask Questions

User Comments

Derek.caldwellteam@gmail.com
ReplyDerek.caldwellteam@gmail.com - 2 weeks ago
I think somebody hit too many numbers on your chart. It's not showing correctly
RobC
ReplyRobC - 1 month ago
Mpmassey,
If you count fixed income as more than CD's or short term/medium term bonds. You could own what I own in low cost Vanguard funds. Long Term investment grade corporate ~5%, High Yield Muni bonds about 4% tax free, High Yield B grade corporate bonds about 5.8% actual payout. These bonds are distinct asset classes and tend to cancel each other out on a risk basis. I also own 20% stocks spread among High dividend yield, convertible securities, REITs, and Small Cap so my stock portion is about 3% Yield. Overall my portfolio dividends are about 4.2% on average over the past 5 years my capital gains have also been about 4% per year on average. I am taking some credit risk and duration risk but I have slept like a baby for the past 5 years. After 2008 I was back to even in capital by November 2009.
Mpmassey
ReplyMpmassey - 1 month ago
Fixed income will realize a real return of less than this over the next 8 years. What to do? What to do?
Himmat ragab
ReplyHimmat ragab - 2 months ago
That's an interesting point. Is it possible the ratio of public to private companies has changed over time and will affect this ratio? For example with Sarbanes Oxley legislation pushing companies to go private or reconsider going public are we left with a greater proportion of private capital?

http://www.ebuystocks.com/
NeilC
ReplyNeilC - 3 months ago
I've always had a problem with organizations that don't use semi-log graphs to portray growth rates. Amazingly, FRED follows this deceptive practice.

On a different note, I couldn't find references suggesting that any of the 7Twelve model portfolios tat use either the Buffett-Munger or Schiler P/E screens. Am I missing something?

Moneycontroltips21@facebook
ReplyMoneycontroltips21@facebook - 5 months ago
Apollo Hospitals Q2: EBITDA margins at 16.4% versus 17.2% (YoY).
Josh Zachariah
ReplyJosh Zachariah - 7 months ago
That's an interesting point. Is it possible the ratio of public to private companies has changed over time and will affect this ratio? For example with Sarbanes Oxley legislation pushing companies to go private or reconsider going public are we left with a greater proportion of private capital?
Gurufocus
ReplyGurufocus - 8 months ago
Buffett's number included private companies. What we have is just for public companies
Bing Garcia
ReplyBing Garcia - 8 months ago
In an interview with Warren Buffett on Dec 10, 2001 by Fortune Magazine, Buffett mentioned the TMC/GNP ratio. His ratio was 200 percent for 1999 and a part of 2000. Your ratio is 148 percent in 2000. Could you please explain the discrepancy? Thank you so much.

Pjmason14
ReplyPjmason14 - 8 months ago
Are you going to be adjusting the data based on the most recent BEA adjustments to GDP?
Gurufocus
ReplyGurufocus - 10 months ago
Sheldon@facebook, the answer is in this page. read it.
Sheldon@facebook
ReplySheldon@facebook - 10 months ago
"The US stock market is positioned for an average annualized return of 2.7%" Can you explain how this number is derived. Over what time horizon is this indicator projected upon? Thanks.
NeumeierS
ReplyNeumeierS - 10 months ago
The download is missing the first quarter of 2005.
FA_suitmoney
ReplyFA_suitmoney - 1 year ago
help mi bagi pinjamuang oy
Jussi
ReplyJussi - 1 year ago
According to this TMC / GNP ratio average is 80 - 85 %. What is the period you have measured to get this average?

I suppose 1970 - 2013 is too short: It includes one normal down period during 70's and beginning of 80's, but bubble of 2000 was mega bubble.
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Gurufocus
ReplyGurufocus - 1 year ago
hi Akarabinos@google,

we are using different total market cap from what Fortune use. We use Wilshire total market index, which cover about 5000 companies and does not cover private companies.

The important thing here is the current valuation relative to historical mean.
Akarabinos@google
ReplyAkarabinos@google - 1 year ago
In a March 1, 2013 Fortune article it says stocks are 133% of GDP as opposed to 101.6% here. Can you explain the difference in the numbers? Here is the link to the article and graph.
http://finance.fortune.cnn.com/2013/03/01/warren-buffett-stocks/?iid=HP_Highlight
Gurufocus
ReplyGurufocus - 1 year ago
Inflation is not adjusted. Inflation is reflected in GDP, in corporate earnings, and in stock prices. The ratio of Stock price/GDP cancels the inflation factor out.
Tstory
ReplyTstory - 1 year ago
How do you adjust for the changes in inflation measures during the Reagan and Clinton years that cause an overstatement of GDP?
Kenokrend
ReplyKenokrend - 1 year ago
Id imagine a larger percent of companies and capital are public rather than private now, compared to the 70s. would this have a material change on the expected ratio of market cap to gnp?
Gurufocus
ReplyGurufocus - 1 year ago
updated, Aspenhawk.

thanks!
Aspenhawk
ReplyAspenhawk - 1 year ago
These last days, the Market-Cap/GDP valuation does not seem to change at all, but the Shiller PE does ?
Kcst1300
ReplyKcst1300 - 1 year ago
Good article, after reading the comments i was surprised no one mentioned how debt (both public and private) plays into this essay. In 1980 total debt was around 160% of GDP,currently it's around 370%. Both GDP and earnings have been juiced as the economy levered up. I wish I knew when the debt party will end, but when it does, we'll see valuations similar if not below 1970 and 1980.
Dagoldsteinny
ReplyDagoldsteinny - 1 year ago
Guru,

This is very interesting to me, but since US companies make a significant amount of their revenues and profits overseas, would it not be more accurate to track market cap vs. global GDP? I think that this metric would show the market to be more attractively valued than by looking at US GDP alone.
Ed Rempel
ReplyEd Rempel - 1 year ago
Hi Guru,

Great article. When I look at the chart, I can't help but be struck by the fact that it shows the stock market was undervalued through the 1970s and 1980s when inflation was high, and is not slightly overvalued when inflation is low.

The "slightly overvalued" conclusion also conflicts with our forward P/E, which is around 12, vs a normal of 15 and a normal of 20 when interest rates are very low.

In general, companies justify higher valuations when inflation and interest rates are very low. This is because the inverse of the P/E, the E/P or earnings yield tends to compare very favorably to other investments like bonds.

My question is - would this not be a more accurate valuation indicator if it was adjusted for inflation (or the inverse of inflation)? That would bring the 70s and 80s up and recent valuations down, with the net effect that the valuation forecasts would be in a much tighter range.

This strikes me as more accurate, as well. Without allowing for the inflation environment, this valuation may be accurate if you assume that inflation will eventually normalize. However, inflation often stays very high or very low for very long periods.

Wouldn't including an inflation adjustment in this model make it far more accurate and useful as a valuation measure?


Ed
VerbalKint
ReplyVerbalKint - 1 year ago
Hi Guru,

As you said yesterday: "we don't have daily Total market cap value in our database. But we can probably do something to make it available."

I'd love it !

When can you do this ?

Would you be able to include a daily refresh of you excel sheet available on download instead of the actual quarter refresh ?
Gurufocus
ReplyGurufocus - 1 year ago
We use Whilshire Total Market Index:

[web.wilshire.com]
VerbalKint
ReplyVerbalKint - 1 year ago
Sorry, I re write:

Could you telle me which data do you use as "total market cap" to calculate your TMC/GDP ratio every day ?
VerbalKint
ReplyVerbalKint - 1 year ago
I'd love it... because I don't know where I could find the Total Market Cap that you use everyday to calculate your ratio.

Qhere do you find this data you use every da
Gurufocus
ReplyGurufocus - 1 year ago
VerbalKint,

we don't have daily Total market cap value in our database. But we can probably do something to make it available.
VerbalKint
ReplyVerbalKint - 1 year ago
FOr the Thick blue line: Ok, I realize that i didn't really understood the exact meaning of that line... Now it's ok.

For the ratio data: the GDP ratio...: ok the GDP is a quarterly data, but the market value is a everyday data: in fact, you give on this page a new ratio everyday...

In conclusion: now that I downloaded you excel sheet with the quarterly GDP data, where can I find the everyday data that you name "Total market cap" ?

With this data, I would be able to create a data sheet, and a TMC/GDP ratio with and everyday value...

Do you have this ? :-)
Gurufocus
ReplyGurufocus - 1 year ago
VerbalKint.

the thick blue line is the actual return of the market during the 8-year prediction period. We will not know the actual 8-year return of today's market until 2020 (always add 8 to the current year). That is why data is only available until about 2004 today.

Because GDP data is only available quarterly, all data are quarterly there.
VerbalKint
ReplyVerbalKint - 1 year ago
One other question:
I downloaded the TMC/GDP data... You put in your excel sheet, the quarter data (4 lines per one year): why don't you give the everyday data, instead of once a quarter ?
VerbalKint
ReplyVerbalKint - 1 year ago
As a premium member, I can't see the thick light blue line in the third graph, after the year 2005...

As a premium member I was expecting a real time data access... Is it correct ?
Polyocho
ReplyPolyocho - 1 year ago
Where do I download the data?
Polyocho
ReplyPolyocho - 1 year ago
How does the average TMC/GDP relate to (Re/Rb)(1/T)-1 ?
Gurufocus
ReplyGurufocus - 1 year ago
"Does this hold true for all countries or is it specific to the USA?"

It is only for USA.

Premium Members can download the data.
Polyocho
ReplyPolyocho - 1 year ago
Can you please provide raw data for one of your calculations so I can get a better grasp on how it is being used and what it represents? For example in calculating the 3.2% currently listed for the USA return what number are you using for Re,Rb and T. Thanks.
Polyocho
ReplyPolyocho - 1 year ago
Ratio = Total Market Cap / GDP Valuation
Ratio < 50% Significantly Undervalued
50% < Ratio < 75% Modestly Undervalued
75% < Ratio < 90% Fair Valued
90% < Ratio < 115% Modestly Overvalued
Ratio > 115% Significantly Overvalued

Does this hold true for all countries or is it specific to the USA?
Gurufocus
ReplyGurufocus - 1 year ago
that is correct Polyocho.
Polyocho
ReplyPolyocho - 1 year ago
Would appreciate your help in understanding the equation regarding the values Re/Rb:

Investment Return (%) = Dividend Yield (%) + Business Growth(%) + (Re/Rb)(1/T)-1

= Current dividend yield + 10-year average GDP growth rate + (Re/Rb)^(1/T)-1

1. Is "Re" referring to TMC/GDP of any date and Rb (beginning) referring to the TMC/GDP of any earlier date, where T= difference in time? For example if the dates were 1/1/2005 and end date was 1/1/2012 then T=7 years?

Thanks

AJ Post
ReplyAJ Post - 2 years ago
"If future market level is high, like the red line, the expected return from this point is high." If you look at the peaks and valleys of your second chart, The Ratio of Total Market Cap to US GDP, from the high of 150% to the 1980 price as well as the 2009 price, wouldn't the green line have the higher
expected return? I'm still struggling with that.
AJ Post
ReplyAJ Post - 2 years ago
I have a little trouble understanding the formula. What is the expected return of TMC/GDP=40 over the next 8 years as well as TMC/GDP =120 over the next 8 years? As I understand it the lower market cap to GDP would produce higher returns. Thanks for the timely replies.
Gurufocus
ReplyGurufocus - 2 years ago
Red, brown, and green lines are not actual returns. They are expected returns if future market is high, median, and low, respectively. If future market level is high, like the red line, the expected return from this point is high.

See this part of the equation in the the text: (Re/Rb)(1/T)-1

AJ Post
ReplyAJ Post - 2 years ago
to add to my question, why does TMC/GDP, of 40 , the undervalued line "generates low returns" as you said?
AJ Post
ReplyAJ Post - 2 years ago
on that chart why does the overvalued line, the red line, perform so well in the next eight years. I know it doesn't on the rest of the page but the chart confuses the data with me. Why does the red line perform 30%?
Gurufocus
ReplyGurufocus - 2 years ago
The 40%, 80%, or 120% lines in the third chart indicate where the return would be if the market-cap/GDP ratio is 40%, 80%, or 120% 8 years from now. A lower future ratio generates low returns.
AJ Post
ReplyAJ Post - 2 years ago
I may be reading the chart wrong, but the last chart on this page the "Predicted and actual stock market returns" with the TMC/GDP ratio seems a little off to me. With the ratio at 40%, the green line, the overall returns are negative. With the ratio of 120 and the market of overvalued and the red line the returns went as high as 30% and finished at 12%. I really like this ratio as well as the fact that Warren Buffet uses this as Top analysis. Can you see if I'm reading the chart wrong? Thanks.

Great website as well!
Mpickering
ReplyMpickering - 2 years ago
Wilshire 5000 total market capitalization is wrong as of 3/2/12. Correct value is $14,192.82

Gurufocus
ReplyGurufocus - 2 years ago
Daisy42,

We can make these data available for download. But like any other downloads, it will be for Premium Members only.

Thanks!

GuruFocus.
Daisy42
ReplyDaisy42 - 2 years ago
I would like to see month-by-month market cap to GDP figures going back to 1971 as shown in the graph, because I would like to calculate the percentile values of each month (or quarter) on a rolling basis. You can see the individual values by mousing over the chart, but copying these down and inputting them to a spreadsheet is laborious and not particularly reliable. I have been able to do this with Shiller's PE10 data. I think it would give a more finely graded asset allocation suggestion than those derived from th broad bands you give. Are you able to / prepared to make the data avilable, or point me to where I can download the historic data myself?

Thanks.
Jhodges72
ReplyJhodges72 - 2 years ago
My mistake, the comment is on the top of the page rather than the bottom.
Gurufocus
ReplyGurufocus - 2 years ago
Jhodges72,

We are aware that Warren Buffett article had a different total market cap from Wilshire 5000; we referred that article many times in the text. We said "not available" meaning that it is not available to us.

We do have our limitations, and we make mistakes. The good thing is that we are always learning and getting better.

Thank you for pointing it out (again).
Jhodges72
ReplyJhodges72 - 2 years ago
I'm well aware of what the ratio represents as I've had in depth discussions via email regarding it with Carol Loomis, who was the first person to write a national article concerning it and is one of Warren Buffetts' closest friends. Its purpose is a bit more detailed than you've described. It is to measure, in actual dollars, how much value Is being created in the U.S. for a given year (GNP) and comparing that information with how much speculated market value the public is pricing a "portion" of the businesses that are represented in the overall GNP number. If the total "public market" is being valued equal to the GNP (actual total market value) then we know the public markets are overvalued because the public market is just a portion that is accounted for in the GNP. the private market is quite relative to the public market but is not accounted for, obviously, in the public markets quotation. All the historical data required to accurately accomplish the "proper" measurement is available. Not for "free" it isn't and is maybe why you're under the impression that it isn't available at all, but it's certainly available. The Warren Buffett article that was written by Carol Loomis used the "entire" historical market, not the Wilshire 5000. Although using it is better than having nothing to go on. I'm just surprised that on a partially paid for and partially free site (GuruFocus) that you didn't know that type of historical data is available. I'm actually blown away by that. The only limitations you are experiencing is do to your own accord, not because the information isn't available.
Gurufocus
ReplyGurufocus - 2 years ago
Also we are aware that Wilshire 5000 does not cover all markets. But the index that cover all markets and have long enough history just does not exist. We do have limitations with data.

On the other hand, what is important here is the current value of the ratio relative to its historical values. The assumption here is that Wilshire 5000 changes in the same way as the whole market. Although it might not be exactly the case, but it is quite close.

Again please understand we are limited by the availability of data.
Jhodges72
ReplyJhodges72 - 2 years ago
Jhodges72
ReplyJhodges72 - 2 years ago
Gurufocus
ReplyGurufocus - 2 years ago
Jhodges72,

We are aware that GDP and GNP are different. We explained in the text why we use GDP.

First of all, historically they are always within 2% of each other. Also GDP data updates much earlier than GNP from BEA website, by using GDP we can update the information earlier.

Jhodges72
ReplyJhodges72 - 2 years ago
You use GDP & GNP in the same statement almost as if they were synonymous. They are not. Also, if you are using the Wiltshire to compare, you do know that you're several billion dollars of capital off because the Wiltshire doesn't account for stocks traded on the OTC markets. That's a huge market place. Nor does it account for private investments, also a huge market place.
Chentao1006
ReplyChentao1006 - 2 years ago
Awesome!
Chentao1006
ReplyChentao1006 - 2 years ago
Awesome!
Arurao7
ReplyArurao7 - 2 years ago
Instead of just Market Cap, why aren't you considering 'enterprise value' of the S&P 500. Isn't that more realistic??

Gurufocus
ReplyGurufocus - 2 years ago
We will add international valuations soon. No. We don't have Tobin Q chart now, but we will look into it.

Thanks!

GuruFocus.
Tuku2400
ReplyTuku2400 - 2 years ago
Do you have a Tobin Q chart
Rjmmd
ReplyRjmmd - 2 years ago
Please add international markets to this site. Please!
Billbyte
ReplyBillbyte - 2 years ago
On market valuation. Long term analysis with adjustment. 10.2.11

[seekingalpha.com]
Billbyte
ReplyBillbyte - 2 years ago
On market valuation. An interesting long term PE adjsutment & analysis.

[seekingalpha.com]
Stavros
ReplyStavros - 2 years ago
Why does your analysis not take into consideration interest rates. In determining whether the market is undervalued, shouldn't the TMC/GDP ratio be influenced by interest rates?
Gurufocus
ReplyGurufocus - 2 years ago
there was a bug from the Data source. It has been fixed.

thanks!
Mledoux
ReplyMledoux - 2 years ago
In your DCF calculator, the benchmark is 11%, i.e., for annual return of S&P. The annual market return, as stated above, is 5.7%. Would it be correct then, to change the benchmark to 5.7% vs 10 or 11%?
Gurufocus
ReplyGurufocus - 2 years ago
In March 2009 you could actually expect 12% a year.
Pjmason14
ReplyPjmason14 - 2 years ago
Question. Using your methodology it looks like the highest starting expected return over the past ten years would have been around 8% annually if you look at the 3/1/2009 figures. Is that accurate or am I missing something in the calculation?

Thanks!
Seanickson
ReplySeanickson - 2 years ago
very helpful, glad to see we're getting closer to normal valuation. I understand that is easier to use GDP but if we look at GNP for q1 2011 it is 15.094 trillion. If the total market is 12.617 trillion then the ratio would be about 83.6 (versus 86.4 using GDP numbers)
Cnarayan
ReplyCnarayan - 2 years ago
Total Market Value (TMC) per Wilshire on 07/20/2011 : 14091
GDP as of the 1st quarter 2011 : 13,444.3
GNP as of the 1st quarter 2011 : 13,655.8
TMC/GDP = 104.81
TMC/GNP = 103.19
Either way (GDP or GNP), market seems to be modestly overvalued.
Advance GDP and GNP as of the 2nd quarter 2011 will be released only towards the end of July. Gurufocus, please correct me if I'm wrong.
Cnarayan
ReplyCnarayan - 2 years ago
Valuable metrics...thanks gurufocus for making it available. I monitor this page frequently and the ratio seems to have dramatically reduced. Used to be 'modestly overvalued' not long ago (over 95%), now its 'fairly valued (less than 85%). Has the change in GDP and/or Total Stk Mkt been this dramatic to cause over 10% change? I find it puzzling indeed.
Cnarayan
ReplyCnarayan - 2 years ago
Valuable metrics...thanks gurufocus for making it available. I monitor this page frequently and the ratio seems to have dramatically reduced. Used to be 'modestly undervalued' not long ago (over 95%), now its 'fairly valued (less than 85%). Has the change in GDP and/or Total Stk Mkt been this dramatic to cause over 10% change? I find it puzzling indeed.
Guru.10302
ReplyGuru.10302 - 2 years ago
Very insightful question. The answer is complex but I will attempt to give a simple one. If government lead the GDP expansion, then it's bound to result in lower market multiple vs. Private cpital led expansion.
Chaim422
ReplyChaim422 - 2 years ago
Does anyone know how to find out what this ratio is for different countries around the world?
Rgarga
ReplyRgarga - 2 years ago
I don't understand how earning yield could be 7% for sp500 and yet we expect net 4% returns... I wonder now with more global nature of companies this metric is not really effective.
Shaftman
ReplyShaftman - 2 years ago
How does the (changing) mix of industries and government spending that contribute to GDP affect this ratio? If government spending or non-productive consumerism make up an even larger slice of GDP, does that argue for a ratio that should be (rationally) lower than the long-term norm?
Shaftman
ReplyShaftman - 2 years ago
How does the (changing) mix of industries and government
Gurufocus
ReplyGurufocus - 3 years ago
No, it includes inflation.
Chris lowe
ReplyChris lowe - 3 years ago
Is the expected average annual expected return of 3.8% calculated net of inflation?
Gurufocus
ReplyGurufocus - 3 years ago
Everything we use here is from GDP. Therefore, GDP growth is the business growth. We do allow dividend distribution. It is a part of investment return.

Hussman uses PPE reverse to the mean, we use TMC/GDP reverse to the mean. In our calculation, profit margin does not play a role, therefore we don't need to do what Hussman and Shiller did to flat the profit margins.

We don't have data for earlier times.
SpatialK
ReplySpatialK - 3 years ago
Yes, intersting to compare this vs Hussman.

Curious to know how you guess at "business growth"; I think Husmanviews this along the same lines as long-run real earnigns growth. Implicitly you seem to allow the reinvestment of earnings not distributed as dividends, so this will give a higher rate than he uses. Is that right?

On the other hand he effectiviely annuitizes the change in the valuation ratio (P/Normalized E) to some long run average (which is why I think he now forecasts barely any return-after inflation). But what do you do. Please clarify.

Thanks for your attention

PS. Do you have data before the 70's?
Jharna
ReplyJharna - 3 years ago
Sorry, but you can not sell me nonsense, claiming to be fresh out of sense. A flaw in your argument is that the future net cash flows are difficult to predict accurately ALSO interest rates are high or low. The definition of intrinsic value is mathematically correct, but not computable. All we can do is our best estimate is to calculate the present value. Unless you think there will be a negative correlation between interest rates and the level of corporate profits, your argument is invalid. Historically, no such inverse correlation. In fact, I read (forgot the source) that profits and interest rates tend to be directly correlated, as long as interest rates are not at extreme levels or lower.
[www.whatisguide.net]
Mony87v
ReplyMony87v - 3 years ago
I would be interested in anyone who could tell me about the Case Schiller p/e index and how it relates to fair value for the market. Particularly, I would like to know how dividends are calculated into his formula. I noticed that dividends at many stretches of the history of the index averaged between 4 to 7 percent with a 10 year trailing p/e of 15. Today the Case index is at roughly 22 x earnings with a paltry yield of less than 2%.

Any info would be helpful.
Gurufocus
ReplyGurufocus - 3 years ago
Thank you for the question, Aagold. It is a great question!

To include the revenue of US companies from international, one needs to use GNP (Gross National Product) instead of GDP, as we explained in the article. But we also explained in the article "The size of the US economy is measured by Gross National Product (GNP). Although GNP is different from GDP (gross domestic product), the two numbers have always been within 1% of each other. For the purpose of calculation, GDP is used here."

Another reason we use GDP here is because GDP data comes out much earlier than GNP data, as you can imagine why.

Thanks!

GuruFocus.
Aagold
ReplyAagold - 3 years ago
Does anybody know what percent of the total US stock market (Wilshire total market) income is either earned abroad or is due to exports? I've heard a few times that the S&P 500 companies this number is about 50% (probably much less for small and midcaps). So my question is, if 50% is anywhere near accurage, doesn't that make comparing the US stock market valuation to US GDP less relevant? It seems like the US stock market valuation should be compared to a weighted average of US GDP and non-US GDP, where the weights are proportional to US-based income version non-US-based income.
Jonathan Poland
ReplyJonathan Poland - 3 years ago
I don't know how anyone can think the market will average more in the next 50 years (10%) than it did in the last 50 years (6.03%). If the Dow Jones averages just what it did since 1960, by 2060 the market will be priced over 214,000. Is this realistic? I don't know. But, it's far more realistic than thinking it will be priced above 1,300,000 as it would if it averaged 10% a year. Guys, it's simple math here.

www.thepolandreport.com
Tanmaysasvavdkar
ReplyTanmaysasvavdkar - 3 years ago
The average rate of return that you can expect long term from the stock market [long term meaning 30+ years] is 10%. 10% in one year is not much and in two or three years 10% a year will not do anything amazing as far as growing money is concerned. However after 10, 20, and even 50 years 10% a year compounded will do unbelievable things to money, even in small amounts.

[www.financialculture.com]
Halis
ReplyHalis - 3 years ago
This is an excellent page that I just discovered. I applaud you providing this to subscribers.
Jehnavi
ReplyJehnavi - 3 years ago
Despite the relative basis, emerging market economies, looks much better than in industrialized countries. I believe that such a fee, which is currently located in emerging markets, valuations are justified to some extent. Unless some of these tightening of monetary policy in emerging economies, I believe the current valuation level is sustainable. We must remember that most developing economies are generally much better than the developed economies expectations of earnings growth.
[www.financemetrics.com]
Tiresias
ReplyTiresias - 3 years ago
guru--

this site would be a more accurate place to get TMV. See the top line. The value is updated monthly

<[www.wilshire.com]>
Tiresias
ReplyTiresias - 3 years ago
guru

apparently your are using ^dwc for tmv; perhaps you should be using ^w5000
Bpengelly
ReplyBpengelly - 3 years ago
Thanks. I was confused because you actually list business growth % instead of GDP % in the formula. You may want to change this to avoid confusing other readers also.
Gurufocus
ReplyGurufocus - 3 years ago
You are using 6% as the business growth rate. In our calculation we use the 10-year average GDP growth rate, which is around 4%. That is the difference.

The market index we use is Wilshire5000.
Bpengelly
ReplyBpengelly - 3 years ago
Can someone please walk me through the expected return formula. I can't figure out how they are arriving at a current 6.2% expected annual return for the coming 8 years. From the above description, here is what I understand the formula should currently be;

Investment Return % = 1.9% + 6% + (((80/80.5)^1/8) - 1)

This ends up with an expected return of 7.9% not the currently listed 6.2%. What am I missing or doing wrong?
Tiresias
ReplyTiresias - 3 years ago
where does he get total market index? is it dow jones u.s.? or wilshire 5000?
Adib Motiwala
ReplyAdib Motiwala - 3 years ago
Hi,

Can you tell what was the TMC/GNP ratio in 2007 2008 and 2009.
Jehnavi
ReplyJehnavi - 3 years ago
All we can do is make our best estimates to actually calculate the present value. Unless you think there will be an inverse correlation between the level of interest rates and the level of corporate profits, your argument is not valid. Historically there is no such inverse correlation. In fact, I have read (forget the source) that profits and interest rates tend to be directly correlated as long as interest rates are not at extreme highs or lows.
[www.financeandmarkets.net]
Superguru
ReplySuperguru - 4 years ago
Do you decide your asset allocation based on market valuation?

Just like Buffett - He was piling up cash when markets were overvalued and as soon as market started going into nosedive he started putting cash to work.

Not sure if he was watching market valuation or he just was not finding anything worth buying at the price offered to him?

Do market valuation matter?
Michaelrahn
ReplyMichaelrahn - 4 years ago
Ok, I actually see where the Predicted Return graph is going. It would be the returns if today's market moved to 40% or 120%. If it moved downward to 40%, it would produce negative returns from today.
Superguru
ReplySuperguru - 4 years ago
"The definition of intrinsic value is mathematically precise, just not calculable." - Buffetteer17

that is what make investing so much fun, hard and challenging...

It is like working with humans... so unpredictable....as opposed to say working with computers or machines.

But great leaders know of how to maximize returns from people..and great investors know how to maximize returns from assets like stocks and bonds without taking too much risk.

Michaelrahn
ReplyMichaelrahn - 4 years ago
Not sure if I am reading the predicted return graph correctly. The green line is for the 40% TMC/GDP, but yet it produces negative returns. Is there a possibility that the red and green lines are each mislabeled as the other? The brown line or 80% TMC/GDP looks fine.
Aagold
ReplyAagold - 4 years ago
As of 3/22/10, the expected returns from the stock market is calculated to be 5.4% per year. Something doesn't seem right.

The first two terms in the calculation are div_yield(%) + business_growth(%), which comes to 1.97% + 6% = 7.97%. The final valuation_change(%) term, if we use fair value = 80% of GDP, comes out to (80/83.9)^(1/8) - 1 = -0.6%. So the average 8-year average return comes out to 7.37%.

Am I making a mistake in this calculation?
Dand49
ReplyDand49 - 4 years ago
Gurufocus,

The total market value divisor is 1059.32 (in millions) and that puts the
total market at 12.293 (in millions) and the full-cap total market at
13.453 (in millions). The percentages are then 86% and 94%. Why don't
you use the US Total Market full cap? The data can be found at
[www.djindexes.com].

Thanks for posting and updating this information.
Latc
ReplyLatc - 4 years ago
Buffetteer17, thanks for your answer. I look forward to seeing your investment returns. By the way, where can I see your returns? Is there a link/website? Best regards

Buffetteer17
ReplyBuffetteer17 - 4 years ago
Latc, what does my track record have to do with this argument? Nothing. That question is implicitly an ad hominem attack on me. You accuse me of attacking you but I have not, at least not intentionally. I only disagreed with your logic and called it nonsense. That's strong language, but I had thought you could tell from the context that the sentence was intended to be humorous rather than vindictive. I guess I just do not have a good sense of humor. That statement is intended as an attack of your argument, not against you. I am sorry if you took it as a personal attack.

Next you make an appeal to authority, by referring to Buffett. I am unsure of just what relationship you are talking about. Is it the fact that stocks are sometimes mis-priced? Buffett has consistently maintained that the intrinsic value of a company is the discounted present value of future "owner earnings," which, while not exactly the same as net cash flows, is pretty close. He apparently believes this strongly, as he put this statement in his Owner's Manual [http://www.berkshirehathaway.com/ownman.pdf]: "Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life."

I will shortly be posting my usual "Quarterly Report on The Porfolio Q4 2009," which will answer your question about my investing returns. You can have the last word in this argument. I am done.
Latc
ReplyLatc - 4 years ago
Buffetteer17, what is your track record on investments, let’s say in the last 10 years? Even Warren Buffett has talked about the relationship that you are dismissing, so instead of attacking show me your performance track record based on your theoretical assumptions.
Buffetteer17
ReplyBuffetteer17 - 4 years ago
I'm sorry, but you cannot sell me nonsense by claiming to be fresh out of sense. The flaw in your argument is that future net cash flows are hard to predict accurately WHETHER OR NOT interest rates are high or low. The definition of intrinsic value is mathematically precise, just not calculable. All we can do is make our best estimates to actually calculate the present value. Unless you think there will be an inverse correlation between the level of interest rates and the level of corporate profits, your argument is not valid. Historically there is no such inverse correlation. In fact, I have read (forget the source) that profits and interest rates tend to be directly correlated as long as interest rates are not at extreme highs or lows.
Latc
ReplyLatc - 4 years ago
Buffetteer17, I know the theory but theory normally does not work, I can not precisely predict net cash flows many years out, can you? Therefore, I just go one year out, in this regard, the current 10 year-Treasury yield is only 3.8% while the S&P 500 earning yield (using the expected earnings for 2010) is around 6.9%, so clearly stocks are undervalued vis a vis bonds right now. I do not have the TM expected earnings for 2010 but I am sure the result will show the same conclusion.
Buffetteer17
ReplyBuffetteer17 - 4 years ago
If you believe that current low interest rates will persist for a decade or more, your reasoning is correct. Reminder: the discounted value of net cash flows is the correct theoretical measure of the value of a stock. However, remember that this formula refers to net cash flows far in the future as well as near term. If you believe, as I do, that interest rates will rise significantly during the next decade, you must use a much higher discount rate for all but the next 2-3 years of net cash flows. This adjustment causes the value of stocks to be much less.
Latc
ReplyLatc - 4 years ago
This stock market valuation TMC vis a vis GDP gives a partial view on the over/under/fair valuation of the stock market. The level of interest rates needs to be incorporated into the equation to provide a more complete view. So, the current low level of interest rates justifies a higher TMC/GDP ratio, hence I would argue that stocks are currently undervalued.
Gurufocus
ReplyGurufocus - 4 years ago
Alahendrix,

We use Wilshire 5000 for the measurement of total market cap, which is different from what Buffett and Van Den Berg use. They use the total of all stocks traded. We do not have the daily data for that. Their numbers are higher than Wilshire 5000.

But relatively speaking, the overall picture is the same.

GuruFocus.
Alahendrix
ReplyAlahendrix - 4 years ago
You guys are calculating TMC/GDP differently than most. For i.e, Arnold Van DeBerg, whom you site, acutally has today's TMC/GDP well over 100%. He pegged it at 108% back in Oct!

So, while using the Wishire 5000 is interesting for your Market Cap input, it is somehow very off from Buffett's data points and Van DeBerg's as well. If you're going to use this metric, you should at least make sure that it is accurate. And clearly it is not!
Latc
ReplyLatc - 4 years ago
Can anybody clarify if the TMC number has been adjusted to exclude foreign ADRs traded in the US? If this is not the case, then stocks might be undervalued.
Hill
ReplyHill - 4 years ago
The first graph - "Total Market Cap and US GDP" would serve better if it were in log scale. The graph gives the false impression that valuations were at record low levels in early 2009. The "The Ratio of Total Market Cap to US GDP" graph gives a much more realistic representation of the relative valuations over time.
Coreythen
ReplyCoreythen - 4 years ago
Does anybody have a website with a similar graph for China's equity markets? In addition, anyone have a graph for the U.S. going back further than 1970? It could be interesting to check out what the valuations were like during the Ben Graham days.
Jackbrugge@comcast.net
ReplyJackbrugge@comcast.net - 4 years ago
The 12/10/2001 Fortune article covering W.B. on the stock market clearly states that TMC/GNP peaked at 190% in 3/2000, not the 148% stated in the GF article. The actual TMC/GNP valuation on 10/9/09 approximates 97%. WB states "... if the percentage relationship falls to 70%-80%, buying stocks is likely to work very well..."
Jcf9999
ReplyJcf9999 - 4 years ago
That looks really cool. This is simple enough to understand. No wonder Buffett is so beloved.

This site just published an article to take this a step further: they backtested this metric as a timing indicator. Interesting is if you only buy at the significantly undervalued and sell at the significantly overvalued, you would have avoided the last two bubbles and made 9.7% (?) per year since 1980. See this link: http://www.validfi.com/LTISystem/jsp/news/2009/09/buffett-stock-market-indicator-simple.html.

Sorry, how do you put an embedded link on gurufocus.com?

JC.
Peterlewis
ReplyPeterlewis - 4 years ago
Any idea what the difference between Total Market Value and Total Market Value - Full Cap on the Wilshire website is? The latter is about 11% higher than the former.
[www.wilshire.com]
Gurufocus
ReplyGurufocus - 4 years ago
Those charts cannot be copied directly. But you can print the screen to PDF file or other image file and crop the charts out.

Sorry about that.
Stcalhou
ReplyStcalhou - 4 years ago
Dumb question - but how can I copy the above graphs?
Mike5885
ReplyMike5885 - 4 years ago
Great info, thank you.
Max7777
ReplyMax7777 - 4 years ago
Thank you for this very useful tool and article.
Abecfilms
ReplyAbecfilms - 4 years ago
Good work here. You can get the raw data here and see for yourself:

[www.wilshire.com]

and here:

[www.bea.gov]

For GNP (which runs approximately close to GDP), click on "Full Release and Tables" in right column, and go to Table 3. GNP appears as the second line from the bottom, "Equals: Gross National Product."

Sabonis
ReplySabonis - 5 years ago
This is really helpful. In fact, I was just searching on line yesterday for this exact info and getting frustrated because it wasn't easy to find the data. Definitely makes my gurufocus.com fees worthwhile.
Kfh227
ReplyKfh227 - 5 years ago
Awesome!


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