The Buffett Valuation Indicator
From time to time I’m asked why I don’t include Market Cap to GDP among the long-term valuation indicators I routinely follow. The metric gained popularity in recent years thanks to Warren Buffett’s remark in a 2001 Fortune Magazine interview that “it is probably the best single measure of where valuations stand at any given moment.”
My friend and guest contributor Chris Turner offered some analysis along those lines last year using the S&P 500 as the surrogate for the market (When Warren Buffett Talks … People Listen). For a broader measure of Market Cap, VectorGrader.com uses line 36 in the Federal Reserve’s B.102 balance sheet (Market Value of Equities Outstanding) as the numerator. Since both GDP and the Fed’s data are quarterly, the folks at VectorGrader.com do some interpolation and extrapolation to produce monthly estimates. Their latest chart is available to the general public here.
The four valuation indicators I track in my monthly valuation overviewoffer a long-term perspective of well over a century. The raw data for the “Buffett indicator” only goes back as far as the middle of the 20th century. Quarterly GDP dates from 1947, and the Fed’s B.102 Balance sheet has quarterly updates beginning in Q4 1951. With an acknowledgement of this abbreviated timeframe, let’s take a look at the plain vanilla quarterly ratio with no effort to interpolate monthly data or extrapolate since the end of the most recent quarterly numbers.
That strange numerator in the chart title, MVEONWMVBSNNCB, is the FRED designation for Line 36 in the B.102 balance sheet (Market Value of Equities Outstanding), available on the Federal Reserve website. Here is a link to a FRED version of the chart. Incidentally, the numerator is the same series used for a simple calculation of the Q Ratio valuation indicator.
For those of you who may have reservations about the Federal Reserve economists’ estimation of Market Value, I can offer a more transparent alternate snapshot over a shorter timeframe. Here is the Wilshire 5000 Full Cap Price Index divided by GDP. I’ve used the FRED data for the stock index numerator (WILL5000PRFC).
A quick technical note: To match the quarterly intervals of GDP, for the Wilshire data I’ve used the quarterly average of daily closes rather than quarterly closes (slightly smoothing the volatility).
What Do These Charts Tell Us?
Both the “Buffett Index” and the Wilshire 5000 variant suggest that today’s market is at lofty valuations, now above housing-bubble peak in 2007.