The market is still expensiveSometimes it is useful to take a step back and look at the big picture. One crucial question that comes up in the ‘big picture’ is how expensive the market is.

One way to tell is to look at market-cap to GDP also known as the ‘Buffett Indicator’. This measure compares the total market cap of all listed stocks and compares it with the country’s GDP or annual income. Markets are supposed to grow in tandem with GDP over the long run and hence an unjustified run-up in the market will cause this indicator to spike and show possible overvaluation.

The SEBI’s recently released Handbook of Statistics on the Indian Securities Market, 2017 shows the movement of market cap/GDP over the past few years. Here it is:

FY BSE Market Cap/GDP NSE Market Cap/GDP
11 94.1 92.2
12 71.1 69.8
13 69.2 67.6
14 75.4 74
15 96.2 94.1
16 75.4 86.6
17 87.8 75.4
18 100 98.8

As you can see from the table above, the market cap/GDP using both stocks listed on the BSE or the NSE is the highest in eight years. This may indicate that the overall market is overvalued.

Critics usually point out that this indicator compares a stock value (market cap) with a flow value (GDP) and hence compares apples and oranges. However, using this measure as a historical comparison tool (with itself in the past) rather than a static comparison tool (with other indicators) will not be vitiated by this criticism. Note, however, that this measure may not be useful for individual companies, sectors or areas of the market (such as large cap stocks).

Buffett Indicator in the US

The Market Cap/GDP ratio in the USA at the end of Q1, FY 19 stood at 142.1%. This is very close to its all time high of 151.3% at the peak of the dot com bubble. However, critics argue that US companies derive a significant part of their earnings (and hence market cap) from outside the USA. In 2016 the share of sales of S&P 500 companies coming from outside the USA was 43%. This can cause the indicator to give an incomplete picture because it is only using US GDP in the calculation and not the GDPs of other countries from which corporate earnings are being derived.

Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at