“Never confuse genius with luck and a bull market” – John C Bogle
During ‘bull’ markets, many investors (and new investment companies) tend to give themselves too much credit for favorable results and to give insufficient credit to the positive environment that played a large role in creating the results. Market Cap to GDP is a long-term valuation indicator that has become popular thanks to Warren Buffett. Back in 2001, he remarked in a Fortune Magazine interview that “it is probably the best single measure of where valuations stand at any given moment.”
The chart below plots the total value of U.S. equities to the total size of the U.S. economy.
However, in his last annual shareholder letter (Feb 23, 2019), he said “In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects,”
What really makes this measure so valuable is that it is very good at telling you what your returns will likely be over the coming decade. As Mr. Buffett has famously said, “the price you pay determines your rate of return.” Pay a cheap price, like investors were able to do back in the early 1980’s, and you will get a fabulous return. Conversely, if you pay a steep price, as investors did 20 years ago, you will get a very poor annualized return over the coming decade. Currently, this measure suggests equity investors will like receive something in the neighborhood of negative 2% per year, including dividends, over the coming decade.
Bottom-line: We are not calling for a recession in the next 6-12 months. In fact, it’s quite possible that the market will shake off the current doldrums and go on to make new highs if a US/China deal is inked and lowered earnings guidance begin to trend back upward. But we are less optimistic about the longer-term prospects for the economy and the stock market. We believe that we are once again headed into a possible lost decade, where average annual returns will be minuscule, if not outright negative. So, stay nimble, be active and don’t just buy and hold what worked during this last 10 years from the 2009 bottom because it will not provide you the same returns over the next 10 years.