In 2001 during a Fortune Magazine interview Warren Buffett said that the stock market capitalization to GDP ratio as a long-term valuation indicator is probably the best single measure of where valuations stand at any given moment.
The stock market capitalization to GDP ratio is used to measure if a market is undervalued or overvalued in contrast to the average of historical prices as a ratio of gross national product. This ratio is a tool used to either look at country specific stock markets or used in the context of the global stock market. This ratio is determined by calculating the stock market capitalization divided by the gross domestic product.
Stock Market Capitalization to GDP Ratio= SMC/GDP×100
SMC=Stock Market Capitalization
GDP=Gross Domestic Product
As of January 21, 2020 currently the stock market is significantly overvalued as measured by the Buffett Indicator. Based on the historical ratio of total market cap over GDP (currently at 157%), it is likely to return -3.2% a year from this level of valuation, including dividends based on historical statistics.
This is a tool for measuring the price you are paying for stocks in relation to national productivity. It shows whether you are getting in to equities as an investment at a good historical value or showing that you could be over paying. This is a macro economic tool for long term investment timing.
