The bulls are quick to cite a dozen or so reasons why the ratio of Market Capitalization to GDP is not an effective valuation indicator – the economy has evolved over time; an increasing share of earnings are sourced from abroad; the components of the S&P have changed dramatically over the years; blah, blah, blah.
At the end of the day, the unfortunate truth is that the folks who take issue with this particular valuation yardstick are the same folks who benefit from telling investors to expect continued double-digit returns from stocks. Don’t ask a barber if you need a haircut.
We are all too quick to trust the experts. We are all influenced by incentives, so much so that if you hope for something enough, you can start to believe it. But sticking your head in the sand won’t change the fact that the chart below, compliments of Hussman Funds, is one of the best valuation indicators in terms of predictive ability.