BS, a reader and friend, asked my opinion of something hedge fund manager Paul Tudor Jones said recently in an interview with Patrick O’Shaugnessy. Jones pointed out that the US is more dependent on equity prices than ever, with the stock market cap currently standing at 252% of GDP – a significant increase from the 65% in 1929 and 170% in 2000. And he suggested that a 35% correction could trigger an economic crisis.
Here’s what I think…
Jones is talking about what is called the “Buffet indicator” – the total stock market value divided by GDP.
And he’s right. At ~250%, it’s historically very high. But critics of this metric would argue that GDP is domestic, but the market cap includes global earnings. And since many large US companies earn a large share of their profits overseas, this needs to be factored in. Another factor is that many of today’s major corporations are high-tech, and they can grow faster than bread and butter companies.
So yes, 250% is, by simplistic historical standards, very high. But it’s not apples-to-apples with 65% in 1929.
When the stock market takes a dip, corporate CEOs slow down hiring and other expenditures, credit conditions tighten, and consumers pull back on spending. That, in theory at least, has a stabilizing effect on the market.
I did some quick AI research and found that we have already had three drops that were close to 35%.
* 2000–2002: ~50% Nasdaq decline, recession mild
* 2008–2009: ~55% decline, but that was a banking crisis, not just equities
* 2020: ~35% drop, economy snapped back quickly
The key distinction, my research suggests, is a matter of “cause and effect.”
If a stock market drop is caused by tightening liquidity or sentiment, it’s going to be painful but will likely be survivable. A drop tied to banking system stress or credit collapse, though, is inarguably dangerous.
The way things have been going since Nixon ended the gold standard is that the Fed is always trying to backstop the stock market through fiscal measures that release liquidity to create some stability. But that stability is temporary – and then the cycle repeats itself and US debt becomes greater and greater. So logic dictates that at some point we could have an economic collapse.
Bottom line: Jones is right in saying that equity valuations are historically high, and he’s probably also right in that the economy is more sensitive to asset prices than before. But to say that the leap to 35% will automatically trigger “systemic economic damage” may be overly simplified.
I hate to say it, but what all of this means to me is that neither Jones nor anyone else can know for sure.
