Market Cap to GDP Ratio: U.S Stock Markets Valuation Technique

Warren Buffett once said that the percentage of total market cap (TMC) to the United States GNP is probably the best measure of where valuations stand at any given moment.

In the past forty years U.S Stock Market history, the TMC to GNP ratio has varied within a very wide range. The ratio was lowest at 0.35 times in the previous deep recession of 1982, while the highest point was 1.48 during the tech bubble in 2000. As a rule of thumb we can broadly divide the market valuation in the five bands based on past records:

Ratio < 0.5 - Significantly Undervalued
0.5 < Ratio < 0.75 - Modestly Undervalued
0.75 < Ratio < 0.90 - Fair Valued
0.90 < Ratio < 1.15 - Modestly Overvalued
Ratio > 1.15 - Significantly Ovdrvalued

As on 13th March 2012 the ratio is 0.96 which suggest that US stock markets are moderately overvalued. Hence investors should cautiously select stocks which are undervalued and provide good yields.