So what does this mean to your equity positioning?
The following chart is used to give a valuation on the stock market and gives you the tool to position yourself. It is based on the total stock index (DWCF) divided by the GNP.
The latest data says that GNP was 16.236 trillion in the first quarter of 2013.
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| Table 1: GDP and GNP |
If we look at the Total Stock Market Index (DWCF), we have 17015.
Now divide 17015 by 16236 and we get: 1.05.
105% is modestly overvalued according to the Stock Valuation Table.
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| Stock Valuation Table |
So I wouldn’t buy equities at this stage.
Since 2008 we have started a new era. We entered the period of deleveraging. For more than half a decade we had an exponential growth system in credit, but we have ended this period. I will show you by analyzing “Total Credit Market Debt”.
Total Credit Market Debt today, is at an astonishingly $55.3 trillion dollars.
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| Chart 1: Total Credit Market Debt Owed |
And it is 350% of GDP.
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| Chart 2: Total Credit Market Debt as a Percentage of GDP |
The total credit market debt = federal/state/local government debt + federal debt to trust funds + business debt + household debt + domestic financial sector debt.
This total credit market debt can be divided by federal debt and private debt.
1) Federal debt: $16.7 trillion.
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| Chart 3: Federal Debt: Total Public Debt |
Federal debt is at 100% of GDP.
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| Chart 4: Federal Debt: Total Public Debt as a % of GDP |
2) Private debt: $40 trillion.
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| Chart 5: Private Debt |
Private debt is at 245% of GDP.
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| Chart 6: Private Debt as a percentage of GDP |
As you can see, since 2008, the private sector has been deleveraging (Chart 6) and the Federal Reserve has been preventing this to happen (Chart 4).
But overall, the Federal Reserve hasn’t printed enough money to keep debt going up exponentially (Chart 1).
So what happens when debt doesn’t grow exponentially? You will get an economic collapse as Chris Martenson explains here.
To read the analysis: go here.
There are several indicators today, marking a major top in the stock market. One of those indicators is the overvaluation in the stock market according to the “Warren Buffett Valuation” of the total U.S. stock market index as compared to U.S. GNP. We found out that stock markets are overvalued today, because the total U.S. stock market index is at 100% of U.S. GNP. Normally we see that the total U.S. stock market index is at 80% of GNP. We just recently had news that U.S. GDP was negative and I wrote about it here. When GDP declines, it inherently means that the stock market must decline, taking into account the Warren Buffett Valuation theory.
Investors are much too bullish on stocks at this moment and we can see that in the Dow-Gold ratio, which is hitting a ratio of 9 to 1 as we speak.
I believe though, we shouldn’t be so complacent about stocks. After all, the P/E ratio of the Dow Industrials stands at 15.3 right now, while in the 70’s, the P/E ratio was on average at 10, which is much lower than 15.3. The question is: “Do we expect higher or lower earnings in the future?”. I believe the earnings are going to get worse in the future. One way to measure this is to look at the Citigroup Economic Surprise Index (CESI). This index is defined as weighted historical standard deviations of data “surprises”. In human language it means that if the index turns negative, the chance of an “unexpected” downward revision goes up. You will hear more bad news out of the media. And what do you know, the CESI did turn negative in the previous month. So you can expect more bad news coming. Historically, when the CESI goes down, the stock market goes down a few months later as you can see on chart 1.
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| Chart 1: Citigroup Surprise Index Vs. S&P |
To read more evidence on a top in equities, go here.
Today I learned about the Warren Buffet valuation of the stock market by looking at the total stock market index and GNP numbers (which is almost equal to GDP numbers + $200 billion).
The total stock market index can be found here and stands at $15.879 trillion on 15 February 2013 (Chart 1). It measures the market cap of the U.S. companies. Don’t confuse this chart with the Dow Jones chart.
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| Chart 1: Dow Jones U.S. Total Stock Market Index |
Now you compare that to the U.S. GDP number, which can be found here (Chart 2).
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| Chart 2: U.S. GDP |
If you then divide Chart 1 by Chart 2, you get Chart 3. If the chart goes above 100%, then the stock market is overvalued.
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| Chart 3: Market Value to GNP ratio |
Here is the table for valuation:
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| Chart 4: Valuation Table |
For example, in December 2007, the GDP was $14.25 trillion, while the total market cap was $15 trillion. 15/14.25 = 105%. Meaning overvalued.
So today, you could say that stocks are becoming overvalued, so you should take some of your money out of the stock market while you still can.
There is a final note I want to make. If this correlation is true between the Total Stock Market Index and GDP, then you have to take in mind that GDP is very important to watch. If the GDP drops, then the stock market will most likely drop. If the GDP rises, then the stock market will most likely rise.
I pointed out many times that U.S. GDP will not go up, due to the zero hour debt problem, which I talked about here. So theoretically, the stock market cannot rise.
The only way to get GDP go up again is when debt is significantly reduced and we’re not at that point yet.
Correlation Economics (Backup) 