Today, I want to bring a simple analysis to your attention. It is based upon the chart of GDP versus the total stock market valuation:

Another measure bodes worse, however. That’s a comparison of the total value of U.S. shares with the yearly output of the U.S. economy (see chart). The stock market is once again the larger of the two. When that happened during a dotcom stock bubble in 2000 and during the U.S. housing bubble in 2006, the result was a stock plunge in subsequent years.

It contains several flaws worth noting.

The first is our longstanding admonition against evaluating investments against a single variable (See this, this and this). But even based on that simplistic analysis, Stocks relative to GDP are not anywhere near a danger zone.

In 2006, stocks crossed GDP at about an 8 trillion dollar capitalization.It took another 4 years and a gap of about 70% ($9.5 trillion GDP vs $17 trillion equity valuation) before the market topped out and reversed.

The same pattern held in 2003 — Equity capitalization crossed at about $11 trillion, and it took another 4 years and 70% before markets topped out near $19 trillion.

Hence, even if you want to use GDP (versus Capitalization) as your single variable, it is rather premature basis for calling the top in equities.

While there are lots of reasons to be concerned about future S&P500 gains, earnings and market cap relative to GDP isn’t one of them.


Single vs. Multiple Variable Analysis in Market Forecasts (May 2005)

Understanding How to Analyze Market Metrics (July 2008)

Complexity, Context, Probability & Bias (March 2012)

Stocks Have Outgrown the Economy
Jack Hough
SmartMoney, May 02, 2012

Category: Cycles, Data Analysis, Markets, Quantitative

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

13 Responses to “Are Stocks Ahead of the Economy?”

  1. DeDude says:

    As all economic activity is moving away from small privately owned businesses to huge companies we should not be surprised to see a larger ratio of market valuation to GDP. Some ratios grow, some decrease and some stay the same.

  2. b_thunder says:

    Unfortunately this chart starts only a year before the market entered the “irrational exuberance” stage.
    But what I can see from the slope of the chart prior to 1996 shows that the total market cap prior to 1996 was significantly less than the GDP.

    So, is the GDP vs market Cap is a good indicator? Well, I think it’s one of the most meaningless indicators. For starters, we don’t even know what % of all business were publicly traded! But it does show (to those who believe this indicator) that when the market cap is close or above the GDP, that means that the market is historically very “rich.”

  3. ottnott says:

    Two whole business cycles in that chart. How definitive.

  4. techy says:

    We need to keep in Mind that US GDP does not matter much for corporations profitability. Think overseas.

    Just like job growth may not correlate with for corporations profitability.

  5. Syd says:

    Other variables besides GDP that have a bearing on market valuation are Fed policy and corporate earnings.

    Bernanke has said the goal of QE is to boost asset prices and thereby raise GDP (spending in the economy) via the wealth effect. Will he be mindful of stock bubbles as he pursues this strategy? Not that the market is as inflated as it got in 2000 and 2007, but if it keeps heading in that direction, will the Fed once again be complacent?

  6. wally says:

    There will always be another recession coming sometime in the future. The chart looks like stocks get about 3 years to outrun the economy before a recession. But, as ottnott says: it’s two cycles (if the word ‘cycles’ can be used with any honesty).

  7. socaljoe says:

    What percentage of the SP500 business is overseas and not subject to US GDP?

    What is the real GDP growth if nominal GDP were to be deflated by the true rate of inflation, not BLS statistically tortured nonsense?

    Stock prices and market capitalization are probably as much due to P/E multiple expansion or compression, as business conditions reflected in GDP.

  8. Futuredome says:

    QE isn’t happening. QE 1 turned into operation twist and QE 2 has been partially phased out(do you people ever read reports?).

    Current “real” stock prices are about 60% lower than the early 2000 top. Come on folks it isn’t that hard.

  9. denim says:

    Hear no evil, see no evil, make no money!
    Diesel fuel indicator chart may be discontinued as the the early warning indicator shows a -1.2% decrease in activity for the previous 3 months.

  10. AlaskanPete says:

    Meaningless when the market is stuffed full of multi-nationals. Take an aggregate global GDP instead of US and you might have something worth looking at.

  11. Syd says:

    “QE isn’t happening”.” -Futuredome

    The Fed buys $25-30 billion in Agency MBS each month as part of its reinvestment of principal payments policy. That’s upwards of $300 billion/year.


    The Fed’s Maturity Extension Program (aka Operation Twist), which involves buying $400 billion of Treasury securities that mature in 6-30 years while selling a like amount of Treasury securities with remaining maturities of 3 years or less, continues until the end of June.

    Also, per the April 25 FOMC statement, additional QE remains an option:

    “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”

  12. bonzo says:

    A number of former US companies are now owned by companies listed on other stock exchanges.
    For example, Amoco was bought by BP, Genentech was bought by Roche, etc. Long ago, virtually all cars in the US were made by US auto manufacturers (the Big 4). Now, a majority are made by foreign companies. Etc. And this is just one of many ways total stock market cap to GDP is really misleading.

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