Comment by stjeanluc

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stjeanluc
February 27th, 2014 at 8:26 am

Interesting article from Barry:

http://www.bloombergview.com/articles/2014-02-26/even-warren-buffett-can-be-wrong-ritholtz-chart



Buffett's favorite metric compares the total price of all publicly traded companies to gross domestic product. This metric can also be thought of as a way to judge the valuations for all U.S. companies relative to the total amount of U.S. economic activity. According to Buffett, when the resulting figure is above 100 percent, stocks are overvalued.[…]

So what does market cap as a percentage of GDP tell us? The answer is: Much less than it used to.

Valuation relative to U.S. GDP assumes that the U.S. economy is the driver of capitalization. It really isn’t. Numerous studies have found very little correlation between current economic activity and the stock market.

Then there is globalization. The percentage of income that the S&P 500 derives from overseas activity is now about 50 percent, up significantly from where it was about 20 years ago — in the 30 percent range. Given that half of SPX earnings are coming from overseas, comparing market cap to U.S. economic activity paints only a partial picture.

Finally, we have to consider the historical track record. This past weekend, Griess noted an interesting anomaly about this indicator to his subscribers. From the time Alan Greenspan first used the infamous phrase “irrational exuberance” in late 1996, stocks have almost always, by this measure, been overvalued. Since October 1996, this ratio has been measured as overvalued (above 100 percent) for all but 17 months (out of 208). That means, according to Buffett’s favorite metric, stocks in the U.S. have been overvalued 92 percent of the time since 1996.

Or maybe we'll see a huge reversal to the mean and all get crushed…. And  he adds:

However, indicators go overvalued/overbought or undervalued/oversold and stay there for much longer time periods than one would think they could.

Which we can relate to!