gross domestic product (GDP) instead of
GNP. To see how well it’s worked in assessing valuations, fire up your thinkorswim®
platform from TD Ameritrade and pull up
the chart of “Stock Market Capitalization
to GDP for United States” (see the sidebar,
“How to View Economic Data”), which is
similar to what you see in Figure 1. Display
the recessions (gray vertical bars). If you
focus on the 2000 and 2008 recessionary
periods, you’ll see the value of the stock
market cap to GDP ratios before the recessions (vertical dashed lines).
In hindsight, it’s easy to see when values
were at medium- to long-term extremes. The
ratio hit a peak in Q1 2000 just as the Nasdaq
and S&P 500 indices were peaking. In Q2
2007, values peaked at a lower level as stock
markets began to roll over. The challenge lies
in figuring out when the next market value
threshold has been reached—in advance.
The data on the chart goes up to Q3 2017.
At that time, the ratio was higher than it
was before the 2000 dot-com crash.
THE NEX T CULPRI T;DEBT
Debt can be a challenge, both in our personal lives and in the market. Debt exists
at all times, but the devil is in the identification of how much debt triggers a stock
Consider Figure 2. If you look at the
same two recessionary periods as in Fig-
bring out old photo albums and walk down
memory lane. And then you think about the
“what-ifs”—all the life-changing scenari-
os that might have happened. To wonder
what might have been is naturally close to a
trader’s heart. Thoughts like “I should have
gone to cash sooner,” or “If I had waited
a couple more days, I would have made a
profit,” or “I wish I’d seen that correction/
Hindsight is 20/20. Yet, to anticipate the
unforeseen is another story. If you look at
past recessions, you may note that each one
had a di;erent major trigger. In 1929 it was a
combination of easy margin debt, rapidly ris-
ing stock prices, the specter of a global trade
war, and rising interest rates. In 2000, it was
a boom in internet and technology stocks,
driven by falling rates and record-high stock
valuations preceding the peak in March. In
2007–08, a housing boom fueled by a sub-prime bubble and “ninja” loans (no income,
no job, no assets) triggered a meltdown
in new-home prices. All this eventually
exposed the vulnerable underbelly of the
market, and we all know what came next—
the rest of the stock market followed.
Whenever there’s a downturn, investors
become fixated on what caused the stock
reckoning. So, in the next downturn, they
tend to focus on the wrong villain. And
although each correction is accompanied
by the usual suspects, the primary catalyst
is often di;erent.
With this in mind, let’s consider some
current usual suspects that could get the
market into trouble.
WHAT’S THE MARKET’S VALUE?
You may have heard of Warren Bu;ett’s indicator, market cap to gross national product (GNP), which suggests whether the
stock market is undervalued or overvalued.
The indicator has been refined to use the
ure 1, in 2000, debt was continuing to rise
even as the stock market was falling month
over month. Although debt relative to the
economy took a one-quarter breather,
it resumed its climb. At that time, debt
seemed like a problem, but that level paled
in comparison to the next peak in Q1 and
Q2 2009. And although the peaks in total
credit market debt and stock market cap-
italization peaked around the same time,
the peak in debt/GDP came 24 months
later than market cap/GDP.
Yet 2009 was di;erent. Interest rates
dropped to record lows in 2008–09, and
have stayed there for nearly a decade. This
suggests the stock market and the economy
are more vulnerable to pressure as interest
rates rise. A jump of 100 basis points when
rates are 10% is much more manageable than
a 100-basis-point rise when rates are 2%.
FIGURE 1: Stock market cap to GDP. The gray vertical bars show recessionary periods. The markets peaked
(yellow dashed lines) in Q1 2000 and Q2 2007. Subsequent lows occurred in Q3 2002 and Q1 2009.
Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
HOW TO VIEW
1. On the thinkorswim® platform from
TD Ameritrade, select the Analyze tab.
2. Select Economic Data.
3. Search for economic indicators such as
“Stock Market Capitalization to GDP for United States” and “All Sectors; Debt Securities
and Loans; Liability, Level.”
U. S. market