In a previous post, we discussed the indicator by which Warren Buffett prices the market and determines the pricing level of the market. Recall the ratio of the market value of all American companies to the GDP of the US. Normally, the fair ratio should be around 0.9. As of today, this ratio is 1.7.
The numbers are much higher than each other, and the market has risen far beyond expectations. The question arises whether the market is in a bubble state and is about to burst soon.
Let us preface by saying that Buffett’s indicator was valid until 2008. Since 2008, this indicator lacks another significant factor that fuels the market far beyond natural growth.
If we look at the graph below, we see that the process of disconnecting the market from GDP began after the 2008 crisis and continues to this day.
This disengagement process can be explained economically and even by a mathematical model.
The economic explanation lies in the fact that after the 2008 crisis, governors worldwide are constantly throwing money at the market.
If we look at the Federal Reserve’s balance sheet graph, we see that the central bank has started a process of printing money from 2008 to this day.
At the end of 2008, the balance sheet stood at about $800 billion, and since 2008 more than 4 trillion dollars have been printed, and the balance sheet has increased fivefold. In practice, what happened is that the Central Bank printed money and bought bonds mainly from American banks. Hence, it maintained the yield of the bonds, even lowered it, injected supply into the market, and threw money to the banks that could distribute it as loans to companies. This is how companies can invest or acquire other companies, encouraging the economy and moving the market up.
After looking at the Federal Reserve’s balance sheet graph, you understand why the market is rising at a much higher rate than GDP growth and natural growth and why this has happened since the end of 2008.
The argument can be reinforced by a mathematical model. In an abstract way, it is said that it is possible to combine GDP and printing money and compare it to the market value. And this is how we get the following fantastic correlation:
This means that the substantial rise of the market can be achieved by combining these two factors. In addition, it can be seen that, as of today, the market is at a cheap pricing point compared to the combination of GDP and money printing, which means that the indices have an upside to rise from the current price point.