Stock Market Capitalization-to-GDP Ratio

What Is the Stock Market Capitalization-to-GDP Ratio?

The stock market capitalization-to-GDP ratio is a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average. The ratio can be used to focus on specific markets, such as the U.S. market, or it can be applied to the global market, depending on what values are used in the calculation. It is calculated by dividing the stock market cap by gross domestic product (GDP). The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator — after investor Warren Buffett, who popularized its use.

Formula and Calculation of the Stock Market Capitalization-to-GDP Ratio

Market Capitalization to GDP = SMC GDP × 1 0 0 where: SMC = Stock Market Capitalization GDP = Gross Domestic Product \begin{aligned} &\text{Market Capitalization to GDP} = \frac{ \text{SMC} }{ \text{GDP} } \times 100 \\ &\textbf{where:} \\ &\text{SMC} = \text{Stock Market Capitalization} \\ &\text{GDP} = \text{Gross Domestic Product} \\ \end{aligned} Market Capitalization to GDP=GDPSMC×100where:SMC=Stock Market CapitalizationGDP=Gross Domestic Product

What the Stock Market Capitalization-to-GDP Ratio Can Tell You

The use of the stock market capitalization-to-GDP ratio increased in prominence after Warren Buffett once commented that it was "probably the best single measure of where valuations stand at any given moment."

It is a measure of the total value of all publicly traded stocks in a market divided by that economy's gross domestic product (GDP). The ratio compares the value of all stocks at an aggregate level to the value of the country's total output. The result of this calculation is the percentage of GDP that represents stock market value.

To calculate the total value of all publicly traded stocks in the U.S., most analysts use The Wilshire 5000 Total Market Index, which is an index that represents the value of all stocks in the U.S. markets. The quarterly GDP is used as the denominator in the ratio calculation.

Typically, a result that is greater than 100% is said to show that the market is overvalued, while a value of around 50%, which is near the historical average for the U.S. market, is said to show undervaluation. If the valuation ratio falls between 50% and 75%, the market can be said to be modestly undervalued.

Also, the market may be fair valued if the ratio falls between 75% and 90%, and modestly overvalued if it falls within the range of 90% and 115%. In recent years, however, determining what percentage level is accurate in showing undervaluation and overvaluation has been hotly debated, given that the ratio has been trending higher over a long period of time.

The market cap to the global GDP ratio can also be calculated instead of the ratio for a specific market. The World Bank releases data on the Stock Market Capitalization to GDP for World which was 92% in 2018.

This market cap to GDP ratio is impacted by trends in the initial public offering (IPO) market and the percentage of companies that are publicly traded compared to those that are private. All else being equal, if there was a large increase in the percentage of companies that are public vs. private, the market cap to GDP ratio would go up, even though nothing has changed from a valuation perspective.

Example of How to Use the Stock Market Capitalization to GDP Ratio

As a historical example, let's calculate the market cap to the U.S. GDP ratio for the quarter ended September 30, 2017. The total market value of the stock market, as measured by Wilshire 5000, was $26.1 trillion. U.S. real GDP for the third quarter was recorded as $17.2 trillion. The market cap to GDP ratio is, therefore:

Market Cap to GDP = $ 2 6 . 1  trillion $ 1 7 . 2  trillion × 1 0 0 = 1 5 1 . 7 % \begin{aligned} &\text{Market Cap to GDP} = \frac{ \$26.1 \text{ trillion} }{ \$17.2 \text{ trillion} } \times 100 = 151.7\% \\ \end{aligned} Market Cap to GDP=$17.2 trillion$26.1 trillion×100=151.7%

In this case, 151.7% of GDP represents the overall stock market value and indicates it is overvalued.

In 2000, according to statistics at The World Bank, the market cap to GDP ratio for the U.S. was 153%, again a sign of an overvalued market. With the U.S. market falling sharply after the dotcom bubble burst, this ratio may have some predictive value in signaling peaks in the market.

However, in 2003, the ratio was around 130%, which was still overvalued, but the market went on to produce all-time highs over the next few years. As of 2020, the ratio stands at roughly 150%.