August 5, 2026
Taking a Walk on the Wild Side
Most people my age will remember Lou Reed’s riské eponymous song, and its hypnotic rhythm, back in 1972. In its own ways, the current stock market is no less seductive as it keeps breaking historical records in spite of unending crises in Ukraine and the Middle East, an increasingly fractious domestic political scene, and persistent inflation.
Nobody has yet timed the market correctly and consistently. If one is smart or lucky enough to sell at the top (and pay taxes on his capital gains), he is very unlikely to repeat and buy back at the bottom. One grows capital by staying, mostly, in the market, not by trying to time it.
But that doesn’t mean that one should ignore the signals given by the market. A well known metric is the so-called Buffett Indicator which compares the annual GDP with the aggregate value of the publicly traded companies. A good way to calculate this metric is to divide the Wiltshire 5000 Index by the US GDP at current prices.
This indicator hovered around 50% in the 1980s before rising to a peak of around 150% with the Internet/Dotcom crisis of 2000. It then fell some 40% in the early 2000s before crashing another 40% with the Great Financial Crisis of 2008. Since then, as the economy and the markets recovered, it relentlessly rose to over 200% with the extra zero interest rate policies of the Covid-19 scare, dropping some 30% as the Fed raised interest rates in 2022. After that, the ratio soared to where it is today, 230%, the result of an accommodating monetary policy, massive tax cuts, the AI led investment wave, and a generally business friendly take on regulations.
Several arguments are advanced to allay the fears that this record level may raise:
- US companies are more internationally active than they were in decades past, and that is not reflected by using just the US GDP numbers. Had we had added the GDP of the OECD ex-US since 1980, the denominator would have been greater, and so the resulting ratio line would have been “lowered” throughout the period. However, since the rest of the OECD didn’t grow as fast as the US, the ratio line would have steepened up in recent years. In 1980, the OECD GDP ex-US was $12 trillion vs. $6.5 trillion for the US (65% of total vs. 35%), but by 2024, the balance was $30.4 trillion vs. $22.8 trillion (57% vs. 43%). Adding China would not have fundamentally changed the trend; it would have lowered the ratio line further but not in a meaningful way as implicitly this ratio relates to profits and US companies tend to be much less profitable in China than in their home market.
- US companies are more profitable today than they have been in the past, which justifies a higher value for the Buffett Indicator. Indeed, corporate profit margins have doubled since 1980. The question is, will this continue in the future? There may be some doubt as both Republicans and Democrats have turned more populist and the days of global free trade may not come back.
Another macro-indicator of corporate valuation is the Schiller CAPE Ratio which aims to uncover long term profitability trends. Specifically, the ratio divides companies’ current stock prices by their ten-year inflation adjusted average earnings. Since 1980, it has fluctuated between 6 and 45. Presently it is around 44.
The same objections that can be presented for the Buffett Indicator can also be advanced here, with the same partial rebuttals.
In summary, we have two indicators of stock market valuation which currently stand at more that double their 50 year average. In the past, this kind of overvaluation was followed by price corrections 30%-40% within two years. Yet, it should be noted that US companies are much more profitable than in the past which should warrant a higher valuation. Whether domestic and international policies will provide the environment for this outperformance to continue is not clear. Whether AI will boost future profits (after eating trillions in investments) or level the field to foster greater competition (and perhaps lower margins) is anyone’s guess.
Nobody can time the market, selling at the top and getting back in at the bottom. But period of high valuations, like the current one, offer opportunities:
- They are a good time to sell mediocre companies the stock prices of which have been undeservedly boosted by market-wide optimism;
- High prevailing stock prices offer the opportunity to get rid of margin loans at little cost, and NEVER take any again;
- While selling just because the market is high is not a good idea, reducing a bit positions which have grown very large and carry very high valuations, or good but not great companies will reduce overall risk and provide ammunition to buy quality stocks when a sharp market correction, inevitably, will occur.
