E Is The Weak Stock Market Predicting A New Recession?

As Paul Samuelson observed in a famous Newsweek article in the 1960s “the stock market has predicted nine of the past five recessions.” Indeed, it is entirely possible that the recent collapse in equity prices is nothing more than a normal market correction in the wake of an extremely strong financial recovery.

The following chart traces the ratio of the Dow Jones Industrial Average to U.S. GDP since 1948. The chart strongly underscores that equity prices have increased faster than the US economy since 2008.

The stock market capitalization to GDP ratio concept is another measure often used to determine whether the overall market is undervalued or overvalued compared to a historical average.

The numerator is the total value of all publicly traded stocks, while the denominator is nominal GDP. This indicator gained notoriety when Warren Buffett commented that it was "probably the best single measure of where valuations stand at any given moment."

In 2000, according to statistics from The World Bank, the market cap to GDP ratio for the US was 153%, a sign of an overvalued market. And of course, US equity markets then fell sharply after the dot.com bubble burst.

It is obviously alarming that the ratio may be even higher today than in 2000.

Ratio Of The Dow Jones Average To US GDP

 Stock Market Capitalization To US GDP 

(Click on image to enlarge)

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