Saturday, 3 August 2013

Stock Market Capitalization to GDP

Stock market capitalization to GDP has been called by some as the best measure of a stock market's valuation (see here)and (here). The market capitalization to GDP ratio is calculated by dividing stock market capitalization by GDP and multiplying the result by 100. This measure can be thought of as an economy wide price to sales ratio. Higher values indicate higher valuations. In general, values over 100 are indicative of over valuations. Lower values indicate lower valuations, but there is considerable disagreement as to what values represent undervaluation in today's environment.

Here is how this ratio compares across time for the United States. While many charts use S&P 500 market cap in the calculation, I have used a more broader measure (non financial corporate business: corporate equity, liabilities) obtained from the Federal Reserve. Notice how the ratio tends to peak before recessions. It wasn't until 1999 that market capitalization to GDP broke above 100% but since that time, it has averaged at a higher value than in the pre 1999 time period. Over the last 10 years, undervaluation seems to occur somewhere in the 60% to 80% range. In any case, the current value is high in an historical context, suggesting that at least from the perspective of this measure, the US stock market is approaching overvalued territory.

Here is a heat map showing stock market capitalization to GDP for a variety of countries. The data are from the World Bank online data base. The most recent measures show that Canada, the United States, England, Sweden, Switzerland, Chile, Malaysia, Thailand, and South Africa are all overvalued. Rewind the slider scroll bar back to 1988 and push play to see how this ratio changes across time.

Market capitalization of listed companies (% of GDP)