Another indicator–market value to GDP–suggests that, after 15 years of overvaluation, stocks are finally reasonably priced. Not cheap, but reasonable. (The original indicator, which we frequently discuss, is the cyclically adjusted PE).
As the chart above from Fortune shows, stocks often do go way below the current level of market-value-to-GDP, and they could easily do so here (stocks traded at about this level relative to GDP in the mid-1930s, and took 30 years for them to get back there). But at least we’re finally near an average level.
Carol Loomis and Doris Burke from Fortune:
The point of the chart is that there should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy – its GNP.
Fortune first ran a version of this chart in late 2001 (see “Warren Buffett on the stock market”). Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks.
But he visualized a moment when purchases might make sense, saying, “If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you.”
Well, that’s where stocks were in late January, when the ratio was 75%. Nothing about that reversion to sanity surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham’s statement about the stock market: “In the short run it’s a voting machine, but in the long run it’s a weighing machine.”
The link above, by the way–Warren Buffet on the stock market–goes to one of the pithiest summaries of what drives stock performance we’ve ever read. We highly recommend it.