Billionaire investor Warren Buffett says the most valuable tool in assessing the stock market is the ratio of total market cap to GDP (both number units are in millions, billions and trillions of dollars). The ratio takes on many variations but all point to the same conclusion. Dividing the Wilshire 5000 Index market cap by the GDP yields the FRED chart above. Multiply the y-axis by 100 to yield a percentage for the ratio. The St Louis Fed provides valuable economic data and charts and the link for the above chart is provided below.
For the red circle, the dotcom bubble top, Q1 2000, the WLSH/GDP market cap to GDP ratio is 1.18 or 118%. The stock market is valued 118% above the GDP an overvalued condition. If the Wilshire market cap is less than GDP the stock market is undervalued. The dotcom bubble pops in early 2000 and stock slide lower into the 2003 bottom which was placed as the bombs fell over the Middle East in the start of the Gulf War. War is bullish. The bright green circle is at Q1 2003 at 0.65 or 65% an undervalued market.
Stocks rally from 2003 to 2007 due to former Fed Chairman Greenspan pumping stocks higher by lowering interest rates. Greenspan wanted to make sure all his rich buddies and the wealthy class as a whole made lots of money and in the process created the housing bubble. The marroon circle is Q2 2007 at 100% where stocks are becoming overvalued again. The housing bubble popped and took everything lower in the 2007-2008 financial crisis.
During 2004 through 2007, anyone that could fog a mirror was given a mortgage loan; that did not end well. The greedy banks packaged the subprime garbage loans (for people that could not afford the houses) in with reliable borrowers' loans and the rating agencies rated this bundle of good and bad debt as triple A. Of course, once the failed house-of-cards system began to collapse it deteriorated into the 2007-2009 financial crisis.
The stock market was never allowed to correct properly in early 2009 as capitalism would dictate and instead former Fed Chairman Bernanke stepped in to stick-save the stock market by implementing QE 1, a crazy Keynesian money-printing policy. The dark green circle is Q1 2009 at 56%.
In early 2009, the politicians, investment bankers and central bankers collude to tell everyone they are saving the financial system to help the common people when in fact this elite class was only protecting their own wealth. They needed to pump stocks higher and save their investments and that was Bernanke's mission. Only a couple months after leaving the Fed, Bernanke was paid a quarter-of-a-million dollars to show up at a token luncheon sponsored by the investment banks. A quid pro quo? This is how the crony capitalism system works in America.
Shamefully, in late 2008, former President George W Bush said he had to destroy capitalism to save it (by bailing out companies and printing money). It is not free markets or capitalism if stocks are not allowed to go through a correction phase and instead everyone wants a constant never-ending rising stock market.
The American financial system is a 'pseudo-free market crony capitalism system'. It benefits about 15 million people at the top of the food chain, the elite privileged class in the United States, while screwing the other 300 million. The central banker easy money pumps stock higher and this behavior continues for the last 8-1/2 years. The final conclusion of the Federal Reserve's grand near-9-year Keynesian experiment has not yet played out.
The pink circle is in Q1 and Q2 2011 at 94%. The blue circle is Q4 2011 at 85%. Bernanke stepped up to the plate proclaiming "QE Infinity." He announces plans to print money like a madman and the stock market took off to the upside again from 2011 forward. In addition, other global central bankers now colluded with the Federal Reserve (BOJ, ECB, BOE, etc...), and this continues through the current day, to continue pumping all global asset classes higher with easy money.
So here we are at the brown circle at 127%-130% the highest ratio number in history. Stocks are overvalued. Can they remain overvalued for many more weeks and months? Sure they can. Can it all collapse and fall apart tomorrow? Sure it can.
If you are a novice investor or young trader, stay away from the stock market this year. If you miss any additional upside in stocks, so what? You are young and will make lots of money on your savings in the future. Sit back and watch how this plays out. You may experience the bargain of a lifetime in 2018 and 2019 with stocks at fire-sale prices.
The biggest beneficiaries after the 1929 stock market crash were the people that had placed all their money in cash and got out of the stock market before it fell apart. Stock prices tumble lower and the prices are extremely attractive but no one had any money to buy after the great wash-out. Those that did have a lot of cash stashed bought blue-chip companies for pennies on the dollar. A few short years later they were multi-millionaires. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.
The FRED chart above can be accessed at the St Louis Fed site.