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For years, Warren Buffett has touted his most favorite stock market valuation indicator. It happens to be a favorite reference for many other industry legends, such as John Bogle, Founder of the multi-trillion-dollar mutual fund company, Vanguard Funds. The so-called “Buffett Valuation Ratio” uses a simple formula: Total stock market capitalization value (as measured by the Wilshire 5000 Index) divided by U.S. Gross Domestic Product. Lately, the result has been interpreted as a warning sign, as it’s hit 1.40, a value not seen since 1999 (pre-tech bubble crash). However, I’m not so sure this metric is as relevant as it once was, as technological innovation and global sales distribution have provided U.S. corporations greater access to better earnings (the key driver of stock prices) more than any time in history.

Furthermore, I can pull data and show a very different relative value result, and that U.S. equities actually have plenty of catch-up before looking overvalued. Let’s first confirm the Buffett Ratio argument that stocks are overvalued. In the chart above, we see price history on the S&P 500 Index (using SPDR ETF (SPY) as a proxy) and compared it to U.S. Gross National Product (GNP vs. GDP is more a personal choice to economists on which to use. I favor GNP as it incorporates the income to all U.S. individuals and businesses globally, not just earned within the U.S.). Using May 31, 1996 as the starting point, it looks as though stocks have experienced significantly higher growth than the underlying U.S. economy, 254% vs. 136%, respectively.

But take a look at the chart below. A simple change to the timeframe interval (advancing it three years to just prior to the tech bubble crash) shows that the U.S. economy has grown much more than stocks, growing 99% vs. 75%, respectively. Is this some kind of analysis wizardry? Hardly, as most analysts know all too well that timeframe matters when trying to assess any type of asset valuation, and particularly so
with U.S. stocks.

Bottom-line: It’s an extremely precarious job of trying to predict stock market values. Various metrics can be devised to support both over- and under-valued theses. For my own part, I prefer the forecast on economic activity based on the growth possibilities within global geo-political policies on trade, regulation, and taxation. All of which still look promising, though the environment could change. However, I wouldn’t bet on significant mid-term negative stock price impact, as the opportunity cost of sitting on the sidelines could be much greater than any short-term volatility.