No. of Recommendations: 19
If the so-called "Buffett Indicator" is to eventually come down, doesn't it have to be the big cap tech stocks market caps that make this happen?
They would definitely have to participate in the fall. In general you don't know whether they will fall more, or less.
I suppose one might look at relative valuations: the three categories are gigacaps, the rest, and Tesla. (whether you count Tesla or not really throws off the figures of whichever group you put it in). The largest 8 firms in my handy database account for 29.5% of aggregate market cap, and 21.4% of aggregate net income in the last 12 months, so they are superficially richly valued. Tesla is the ninth. The next 8 account for 10.6% of the aggregate remaining market cap but 12.7% of the remaining aggregate profit. i.e., beyond the top 9, the next large caps are superficially not overvalued on a current earnings basis: less so than the long tail. We all know that trailing earnings yield isn't a great metric of valuation for a firm because only relatively distant future earnings really matter, but it's not entirely useless for a biggish group of firms.
The market-cap-to-GDP ratio is good but not perfect, as there a lot of moving parts. For example, the fraction of the US economy which is accounted for by public companies changes over time. The amount of the economy serviced by non-US corporations changes, and the amount of US stock market value coming from non-US GDP sources changes.
The latter effect is quite a bit smaller than most people suppose, though: big US companies were big exporters even decades ago. The fraction has risen, but not enough to change the shape of that graph.
Personally, to get an idea of broad market valuation levels, I prefer to look at smoothed real profits of the same set of companies that I'm looking at the price of. Given how much tax rates have changed, it's perhaps useful to look at that as smoothed pre-tax profits as well as smoothed net profits. One tells you what to expect if tax rates stay this low, one tells you what to expect if they go back to the old normal. The truth might be between the two. Maybe.
The hackneyed quote is that compound interest is the strongest force in the universe. I think it's mean reversion. Things rarely mean revert completely, no matter what you're measuring. But some degree of mean reversion is vastly more common than a metric just keeping on drifting further and further away from its historical range. No matter what millennium you're talking about, an established business activity earning $X per year will most often sell for between 5 and 25 times X, and figures closer to the middle are much more common than figures at the extremes.
Jim
