Sunday, February 9, 2014

Buffett valuation of stock market



Hat tip to zero-hedge for reminding me of the old and simple valuation of the stock market used by Warren Buffett. No need for P/E or B/P or other more complex measures. Just take the market valuation and divide by the GDP. It is available on the FRED database. When the market cap to GDP gets too high, the market is in trouble.

Now this is just one tool and there are problems with the measure like the large secular increase post-1995. It is hard to say what should be the true relationship between equities and GDP. All we can say is that the market cap has had a significant rise into territory which should make any asset allocator to stocks nervous. 

I am curious about the big declines. Are these bubble crashes? What happened in the 1970's when we had stagflation? If you extrapolate the trend from the pre-1995 period, we may at a level closer to this trend, but that begs the question of what had happened over the last fifteen years.

Still, if you want one simple measure, this is a good place to start and you are in good company using it.


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