Alternative view on equity valuation (modification to Buffett Indicator)

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HanSolo
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Joined: Thu Jul 19, 2012 3:18 am

Alternative view on equity valuation (modification to Buffett Indicator)

Post by HanSolo »

The question sometimes arises, whether the US stock market is "high" or "low" by historical standards.

Some look at the "Market capitalization-to-GDP ratio" (also known as the "Buffett Indicator", since Warren Buffett mentioned it before) as a valuation metric.

Aside from that, some say that government spending and the Fed balance sheet have some influence on equity prices.

In order to incorporate all of the above, I did a calculation, dividing the Wilshire 5000 by the sum of GDP, federal debt, and the Fed balance sheet. Here are the results for the past 19 years (2002 - 2020):

Code: Select all

Key:
wilsh = Wilshire 5000 (https://finance.yahoo.com/quote/%5EW5000/history)
gdp = U.S. GDP (https://fred.stlouisfed.org/series/GDP)
bal = Federal Reserve balance sheet (https://fred.stlouisfed.org/series/WALCL)
debt = U.S. Federal debt (https://fred.stlouisfed.org/series/GFDEBTN)
denom = denominator (gdp + bal + debt)
gdp% = percentage contribution of GDP to denominator
ratio = wilsh / denom
All figures in denominator are in billions of USD.
All figures are year-end figures.

Results:
year wilsh   gdp   bal  debt denom  gdp% ratio
2002  8343 11061   732  6405 18198   61%   46%
2003 10799 11772   771  6997 19540   60%   55%
2004 11971 12527   810  7596 20933   60%   57%
2005 12517 13324   847  8170 22341   60%   56%
2006 14257 14039   869  8680 23588   60%   60%
2007 14819 14715   890  9229 24834   59%   60%
2008  9087 14608  2239 10699 27546   53%   33%
2009 11548 14651  2234 12311 29196   50%   40%
2010 13360 15309  2420 14025 31754   48%   42%
2011 13189 15842  2926 15222 33990   47%   39%
2012 14995 16420  2907 16432 35759   46%   42%
2013 19706 17133  4032 17156 38321   45%   51%
2014 21669 17852  4497 18141 40490   44%   54%
2015 21167 18332  4486 18922 41740   44%   51%
2016 23425 18968  4451 19976 43395   44%   54%
2017 27794 19882  4448 20492 44822   44%   62%
2018 25749 20813  4075 21974 46862   44%   55%
2019 32886 21694  4165 23201 49060   44%   67%
2020 39456 21477  7363 27747 56587   38%   70%
Interesting takeaways:

1. Most of the ratio figures (14 out of 19) are in the range of 40 to 60. The average is 52. The median is 54.

2. The contribution of GDP to the denominator had stabilized for several years at 60%, then later stabilized again for several more years at 44%. Also, this number seems to go only one direction (down).

My question is, does this calculation provide a better assessment of valuation than the unmodified "Buffett Indicator"?

Please note that I'm not claiming this to be the new be-all end-all indicator. It's just an experiment.

Please also note that I'm not asking or asserting anything about the future (e.g., predictive value). While some may want to use it in that way, others may simply want to gain a better understanding of equity pricing.
Strategic Macro Senior (top 1%, 2019 Bogleheads Contest)
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