Chris Turner has a guest post at Doug Short’s Advisor Perspectives called When Warren Buffett Talks … People Listen examining Warren Buffett’s favored market valuation metric: Market Value divided by Gross National Product. (I’ve also examined market value-to-GNP several times. See Warren Buffett and John Hussman On The Stock Market, FRED on Buffett’s favored market measure: Total Market Value-to-GNP, The Physics Of Investing In Expensive Markets: How to Apply Simple Statistical Models)
Here Chris looks at the metric using the CPI deflator on both the numerator — market value — and the denominator — Gross National Product.
Here Chris calculates two fair values for the S&P 500. The blue line shows the historical mean and the green line shows Buffett’s 80 percent value estimate:
Chris comments:
Readers can see from the chart that based on both Buffett’s rule and the historical mean, the S&P would be trading much lower from present levels. The S&P would be sub 1000 based on the historical mean and around 1150 based on the 80% Buffett rule.
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Does corporate cash/debt play into this? It seems if NET cash has a % of TMC has gone up significantly, as I think it has, that this has to be netted out some way to make TMC comparable from period to period particularly across decades
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[…] more on market value-to-GNP see my earlier posts Warren Buffett Talks… Total Market Value-To-Gross National Product, Warren Buffett and John Hussman On The Stock Market, FRED on Buffett’s favored market […]
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I’m gobsmacked by the vitriol in the comment section. Tobias, this is an excellent repost of a very thoughtful analysis by Chris Turner.
Buffett is irrelevant as a stock timing indicator; he has no choice but to talk his book.
There is very good evidence based on long-term Q ratio, smoothed PE, price regressions, and mkt cap / GNP metrics that the market just reached FAIR VALUE in March of 2009, and that stocks have essentially been in bubble territory since 1994, with the exception of the few months near the bottom of the 08/09 bear.
Low interest rates and QE are the ONLY driver of current bubble valuations, and when the music stops stocks are going to endure another protracted bear market for a decade or more to correct the current excesses.
Those who insist on using irrelevant metrics like TTM PE or forward operating PE to value stocks have been deluded by the biggest sales machine on earth – the Wall Street Complex. We’ve probably borrowed 20 years of future returns to push prices to these levels.
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[…] on Greenbackd over the last month or so (see, for example, the Shiller PE, Buffett’s total market capitalization-to-gross national product, and the equity q ratio, all three examined together in The Physics Of Investing In Expensive […]
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Here is Buffett in May 2007 “bullish” on the US stock market…
http://money.cnn.com/2007/05/05/news/newsmakers/buffett/
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For what it’s worth, Buffett told Reuters today that he doesn’t think the stock market is in a bubble. He said the market is neither cheap nor high-priced.
http://www.reuters.com/article/2013/05/04/berkshire-agm-markets-idUSWEN008VN20130504
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This is such an ignorant line of thought — to take an index that consists largely of globalized multinational companies and compare it to the GDP of a single sovereign home nation. I can’t even believe you are furthering this line of thought with more posts on the matter.
With all the uncertainty around the Chinese economic model and messy central banking policy, hammering home this critique current environment is moronic.
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Chris hasn’t done as you have suggested. He has compared it to GNP. It makes perfect sense to me to take an “index that consists largely of globalized multinational companies” and compare it to gross national product, which 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).
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GNP picks up foreign earnings dollar for dollar. Total market cap is picking them up at 15x or whatever the multiple is. So the ratio of total market cap to GNP should be higher today (given 50% of S&P earnings are from overseas) compared to the past.
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I don’t think Buffett’s 80% rule should be viewed as a mid-point. Buffett did not wade into the waters in Oct. 2008 at what he thought was the mid-point. I would consider it a lower bound. Panic selling, like in March 2009, can always take things lower, but one can’t make any predictions on that with confidence. Thus, I think Buffett decided to move when it hit his lower bound, and then added as panic selling took it down further.
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The mid point is the Fair Value Historical Mean, marked on the bottom chart as a blue line.
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You are talking about the bottom chart, right? How can the mid-point be below the lower bound 80% Buffett line?
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Chris finds the historical mean of the ratio to be ~67%. He included a line indicating the point at which the ratio would be 80% because Buffett said in his 1999 article:
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The historical mean is 67%? So the low point in March 2009? The bottom of the Great Recession is not the reasonable mid-point range that people should think about. Come on Toby.
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The chart deviates from the blue – green channel, and it might be worthwhile to speculate why.
1970’s–Interest rates were very high, which forces valuations down.
Today–Interest rates are very low, which forces valuations up.
2007–Profits at financial institutions were out of whack.
2002–?
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Keith,
For my 2c, I still think this is the best essay on the topic: Warren Buffett, Mr. Buffett on the Stock Market (November 1999).
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Tobias,
Good article. Thanks.
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