What Warren Buffett’s Market Cap-to-GDP Indicator Tells Us About U.S Stocks

During their recent episode, Taylor, Carlisle, and Brendan Hughes discussed What Warren Buffett’s Market Cap-to-GDP Indicator Tells Us About U.S Stocks. Here’s an excerpt from the episode:

Tobias: Yeah, thinking of you guys. Are there any lessons from all of these crises? What’s the takeaway in your mind? What should we be careful of? What should we look out for? And what do you see when you look out today in the US?

Brendan: Yeah, I’ll start by touching on the US markets today. And I wanted to go back to a Warren Buffett quote in 2001 article where he said, in reference to the indicator that compares the total market capitalization of all actively traded US stocks to the latest estimate of GDP. And he said that is probably the single best measure of where valuations stand at any given moment. I can’t speak for Mr. Buffet, but that probably has at least something to do with his recent selling activity in the equity markets.

US stocks are expensive by historical standards. But as I noted in my book, I do think that dollar cost averaging over long periods of time does help mitigate some of the valuation risks that you see. This is really important because I don’t think it’s almost ever a good idea to jump in and out of the market. Now, you might be more aggressive and less aggressive based on where valuations are, and I think today, it’s more appropriate to be cautious. But virtually all the market returns are earned in the few days per decade when people least expect it. I think that’s really important.

I’m going to go back to a research study that was conducted and it noted between 1930 and 2020, you would have earned a 17,700% return if you stayed fully invested in S&P 500 equivalent. Now, I don’t know if the next 90 years or 100 years will produce anything close to that, but if an investor had missed just the ten best market days per decade over that period, they would have earned a cumulative 28% return compared to the 17,700% return if you just stayed fully invested. And I think that’s important to point out and that’s one of the things that I did note in my book.

But other than things like that I noted earlier by focusing on companies with more flexible capital structures, I think looking at other things, I do think that there is something in the place for a portfolio for country diversification. I know some people argue that you can get a high element of country diversification if you have a US company involved in another market, and that is true, but it doesn’t prevent– I don’t think it fully protects you from some situations where governments start to confiscate assets and things like that, I think you do get a little bit more defense against something like that if you do have some element of country diversification.

And to me, having gone back and studied various financial crises, pandemics, things like that, it starts to rhyme. I think even looking at what’s happening now in the Middle East, I drew some parallels to the 1970s energy crisis. You can go back and look what types of assets did well during that period. For example, defense stocks did very well during that period. You see defense stocks doing well now. So, I think the more an investor goes back and studied what has happened, the better prepared and the more knowledge they have that helps them prepare for the future.

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