The Stock Market & Gross Domestic Income: A Crucial Correlation

Last week I covered how investors are banking way too heavily on the stock market and don’t have enough stored in liquid assets.

This week I wanted to highlight another metric that puts the valuation of the stock market in rarefied air — so much so that we’ll need an oxygen mask to survive up here much longer!

That metric is the ratio of the total value of the stock market… to nominal gross domestic income.

Past major market peaks tend to coincide with extreme levels of both extreme levels of market valuation and GDP. That’s why this correlation is so crucial.

Currently the stock market is valued at 137.2% of GDP, up 7% from January. That’s one of the highest levels ever! Take a look:

Stocks to GDI

As you can see, we are well past the “overvalued” threshold. We are officially in “bubble territory.”

Bubbles end badly. Unless you’ve been hiding out in a bomb shelter, you remember the last two bubbles we’ve been through — although I often fear people have short memories when it comes to this kind of stuff…

During the dot-com or Internrnet Bubble, the percentage of market value to GDP was 164%. Interestingly, it was in bubble territory a few years before the air came out of the market.

But even more interesting is that, even though the market suffered tremendous carnrnage after the Internrnet Bubble popped, we never got out of bubble territory.

That caused us to relive the nightmare all over again when the next bubble came crashing down after its 2007 top. Only then did we get a “reprieve” — a word I struggle to use considering stocks were down over 50% and millions of people lost their homes.

From the 2007 top of 124.8%, the ratio reached 58.1% just a few days before the stock market bottomed in 2009.

Now, just six years later, we are even higher than both the 2007 and 1929 tops.

It’s going to get worse before it gets better, meaning it will be some time before we see good buying opportunities again. The 1982 bottom proved to be one of the best times to buy stocks in the entire century, as it was followed by a massive secular bull market. The 1990 recession also presented a good opportunity. We’ve got a long way to fall before we see that again.

And it doesn’t mean the market cannot go higher. It can take years for a bubble to pop.

But we’ve already been in this bubble for about four years. We are closer to the end than the beginning.

That means investors should be cautious about new capital they commit to the market, and at least start to tighten stops on existing positions.

John Signature