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Last Updated : Sep 09, 2020 02:18 PM IST | Source: Moneycontrol.com

Market cap-to-GDP ratio moves above long period average; time for caution?

The ratio, which is also known as the Warren Buffett indicator, compares the value of all stocks at an aggregate level to the value of the country's total output.

The market cap-to-GDP ratio has moved above the long period average after hitting a 10-years low back in FY20, data showed. This suggests that the market might be heading towards an overheated zone and its best to turn cautious.

The market cap to GDP ratio moved from 79 percent in FY19 to 56 percent (FY20 GDP) in March 20 to 79 percent now (FY21E GDP) – above its long-term average of 75 percent, Motilal Oswal said in a report.

In terms of valuations, the Nifty is trading at 12-month forward RoE of 12.5 percent, below its long-term average of 13.9 percent, added the report.


The ratio, which is also known as the Warren Buffett indicator, compares the value of all stocks at an aggregate level to the value of the country's total output.

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A value above 100 percent indicates that the market is overvalued while a number close to 50 percent indicates that it is undervalued. The ratio is more applicable to developed countries and might not reflect the true picture for investors here in India, suggest experts.

“Market Cap/GDP indicator is more relevant for US and other western countries where interest rates are almost zero (or –ve as of now),” Amit Jain, Co-founder & CEO, Ashika Wealth Advisors told Moneycontrol.

“In our view, lower the rate of interest, higher the market cap to GDP ratio will be. For India, whenever this ratio comes closer to 85, then there are higher chances of correction in the market. In 2008, this ratio had crossed 100,” he said.

Motilal Oswal Mcap1

Why is it not relevant for India?

In 2019, India Inc saw robust investment momentum from private equity with a total investment of $37 billion as compared to $36.16 billion in 2018, according to a media report.

The true market cap to GDP ratio is slightly skewed as the PE investments which came in large numbers have not been captured while considering market cap, suggest experts.

“If one assesses the impact of COVID -19 which would largely materialise going ahead, the growth is projected to contract by 3.20 percent in FY2020-21 (World Bank),” Umesh Mehta, Head of Research, Samco Securities told Moneycontrol.

“Therefore, even though this ratio looks attractive but optically it is still on a higher side taking into account the PE investment and true GDP picture,” he said.

What should investors do?

The market cap to GDP ratio can’t be trusted, but it would make sense if investors include valuation as a parameter when making a buy or sell decision.

Investors should not base their decision on just one parameter. Given that the ratio is slightly skewed, the market cap to GDP ratio may be near its long-term average or slightly below but it is absolutely not at low levels on a like to like comparison.

“No investor should base his/her decision basis such ratios. It is clear that money is made on the foundation of portfolio construction and staying with good quality businesses which would create wealth for an investor in the long run,” says Mehta of Samco Securities.

“Therefore, one has to be selective and focus on stock and sector-specific investment ideas rather than mulling on such macro-economic indicators,” he said.

In terms of valuations, the Nifty is richly valued when compared to mid-caps, and small-caps as of now which also warrants cautions going forward.

“As of now, Nifty is trading at a P/E close to 32x, which is almost a decade high valuation, hence, the risk-reward ratio may not be favorable.  I am not a big fan of predicting numbers for the index, as we have seen in the past, at times the index remains flat, but individual stocks do very well,” says Jain of Ashika Wealth Advisors.

“For example, Index has generated a CAGR of 8 percent in the last three years, but there are a lot of Individual stocks which doubled during the same period, so ace investors should focus on right sectors & companies rather than broad index numbers,” he added.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
First Published on Sep 9, 2020 02:18 pm